ON Securities : Securities Lawyer & Attorney for Corporate Governance & Executive Compensation Matters

This time of year, many public companies are drafting the Compensation Discussion and Analysis section of their proxy statement, including a description of how the company’s executive compensation program aligns the interests of executives with those of shareholders. But do the elements of compensation always have the desired effect? Not according to one compensation consultant.

Jim Sillery of Buck Consultants today gave an entertaining presentation to the Twin Cities Chapter of the National Association of Stock Plan Professionals entitled “Achieving Equity Effectiveness: A New Understanding.” Sillery gave several examples of studies showing that equity awards often do not provide the intended motivation for employees, including executives. Among his points:

• Stock options became popular in the 1990s, at a time when there was unprecedented appreciation in stock price. Stock options had great motivational value (after all, the stock always went up), with no “cost” from an accounting point of view. Now, following two recessions in the past 12 years, stock options are underwater in many cases and don’t have the same motivating effect. At the same time, after changes in accounting rules, increasing shareholder activism and the imposition of mandatory shareholder votes on executive pay, options involve significant downsides.
• Sillery discussed the concept of “equity effectiveness” – finding the point where the motivational value of compensation awards outweighs the costs, administrative effort and other negatives of a compensation program. In other words, balance the “right brain” factors that cause employees to perceive value with the “left brain” factors that cause headaches for the company – tax treatment, accounting treatment, compliance issues, etc.
• Sillery discussed the characteristics of stock options vs. time-vested restricted stock vs. performance shares. As he shows in his presentation (PDF) (slide 17), the different types of awards have differing advantages in terms of potential appreciation, stability, etc. A lot of the value in each awards is in how they are communicated to employees. He describes a “kitchen table” test – would the participant be able to describe to a spouse the basic features of the award and how it will benefit them?
• In an interesting sequence, he described generational and cultural differences that affect which type of award might provide the proper motivation. Baby boomers, Gen X’ers and Gen Y’ers have differing characteristics that may make different types of awards more attractive. Also, for global companies, employees from different countries have radically different perceptions that affect their perceptions of value, long-term vs. short-term view, etc.
• Sillery said he often recommends that companies consider increasing in the performance shares component of equity compensation to provide flexibility. For example, the company can vary the terms of awards in terms of leverage/risk, performance metrics, payout, etc., to adjust for cultural differences in different countries and regions or for different categories of employees, while keeping the basic structure of the awards constant.

Public companies will always struggle to find the right compensation mix to properly motivate executives while minimizing costs and headaches. Maybe the best approach is to get a degree in psychology.
 

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As we approach the second proxy season featuring Say-on-Pay votes, public companies are under increasing pressure to describe how executive pay is tied to company performance. The compensation consulting firm James F. Reda & Associates recently issued its “Study of 2010 Short- and Long-Term Incentive Design Criterion Among Top 200 S&P 500 Companies” (PDF). This study provides a good snapshot of the types of practices large companies used in 2010 (reported in 2011 proxy statements) to provide the proper incentives to executives. Among the findings:

• Although stock options remain popular, for the first time, the prevalence of grants of performance-based awards (performance shares, performance units, etc.) exceeded the prevalence of stock options (including stock appreciation rights).
• For short-term incentive plans (generally annual bonus plans), earnings per share and income were the most common performance measures, followed by revenue, capital efficiency ratios and cash flow. For these plans, 72% of companies used two or more financial measures. Over the past several years, the percentage of companies using only one measure declined.
• For long-term incentive plans, earnings per share and income were the most popular measures, followed by total shareholder return (TSR) and capital efficiency ratios (return on invested capital, etc.). For these plans, 40% of companies used only one measure, with this number declining. Almost the same percentage used two measures, with a smaller number using three or more measures.

The study also provides a lot of detail on target levels, maximum payouts, disclosure practices, etc. As companies are finalizing their 2012 compensation programs and preparing their proxy disclosures, the study should provide a useful reference.

Facebook’s Governance Structure: Not Everyone “Likes” It

As reported in this recent post, Facebook, Inc., which is preparing for its IPO, has a dual-class voting structure that gives founder Mark Zuckerberg a lock on controlling the company, now and for the foreseeable future. Now, certain shareholder groups are expressing their disapproval.

Earlier this week, the shareholder advisory service ISS published a research note that criticizes Facebook’s governance structure, as described in this DealBook post. One of ISS’s statements: “This is a governance profile with a defense against everything [but] hubris.”

Further, as reported by Bloomberg, the California State Teachers’ Retirement System (CalSTRS), which is an existing investor in Facebook, is planning to send a letter to the company questioning the governance provisions.

Of course, one of the features of Zuckerberg’s super-voting stock is that he is not required to listen to any outside parties who might criticize these practices. And if investors don’t like these governance provisions, they don’t have to invest. But it will be interesting to see whether there is so much criticism that the underwriters have to press for some changes in order to attract investors. The way it looks right now, this will be a hot stock no matter what. But stay tuned . . . .

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As nearly everyone knows by now, Facebook, Inc. filed its initial registration statement yesterday with the SEC, leading toward an initial public offering. As the filing reveals, Facebook’s corporate structure includes some corporate governance provisions that founder Mark Zuckerberg and other insiders are certain to “Like”.

In a post on the DealBook Blog, “A Big Bet on Zuckerberg,” Steven Davidoff reports that Facebook, Inc. is structured to give Zuckerberg a lock on controlling the company, now and for the foreseeable future. The existing Class B shares carry 10 votes per share, compared to 1 vote per share of the Class A stock being offered to the public. Because Zuckerberg obtained voting agreements from many other early stockholders, he essentially has complete power to select and remove members of the board of directors. Professor Davidoff points out that investors in Facebook are placing a major bet that Zuckerberg will manage the company effectively.

Zuckerberg’s control even extends past his death. According to the "Risk Factors" section of the prospectus, “ . . . in the event that Mr. Zuckerberg controls our company at the time of his death, control may be transferred to a person or entity that he designates as his successor.” Can you say “dynasty”?

Facebook also has other management-friendly governance provisions built into its structure. For example, the registration statement reveals that, once the Class B shares no longer control the company, the board will be classified into staggered terms, and directors will only be able to be removed for cause. Further, at that time, vacancies on the board will only be able to be filled by the board and not by the stockholders, and amendments to the charter or bylaws will require a supermajority vote.

Some of these governance practices, which would be next to impossible for an existing public company to implement, are common for companies doing IPOs in the past few years. As shown in this Conference Board study (PDF), companies that recently did IPOs have a much higher incidence of practices such as classified board, which are unpopular with many institutional investors. The practices differ even more at “controlled companies” like Facebook, in which a group retains voting control.

All of this seems fine – when a company like Facebook goes public, any investors who don’t like the ground rules can simply refrain from buying the stock. But it’s interesting that this recent trend in IPO companies’ governance is creating a group of companies that, going forward, will feature fewer investor-friendly governance practices than companies that went public in earlier times.

If you are not used to scouring through prospectuses and you want a guide to Facebook’s, check out this great interactive DealBook feature, “Documents: Understanding the Facebook Prospectus,” which includes the editors’ comments on notable parts of the document.

“The Social Network” Shines

Looking at the Facebook prospectus reminded me of how much I loved the film “The Social Network”. And seeing Sean Parker’s name in the prospectus, I can’t help but think about Justin Timberlake’s great performance in that movie, including the following line, which should have been included in the prospectus:

Sean Parker: You don't even know what the thing is yet. How big it can get, how far it can go. This is no time to take your chips down. A million dollars isn't cool, you know what's cool? . . . . A billion dollars.

Try $100 billion, speculated to be the top of the valuation range for the company once it is public, according to this Wall Street Journal report.

See this prior post, with some comments on what the film says about the changes in our society.

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