January 23, 2023 | Wachtell, Lipton, Rosen & Katz
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Thanks to Adam J. Shapiro, Michael J. Schobel, and Erica E. Bonnett
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Economic volatility dominated the corporate landscape in 2022, with inflation and stock price declines making headlines throughout the year, while the labor market remained surprisingly resilient, reinforcing the scarcity and value of key talent. We identify below some of the fundamental themes that may shape company compensation decisions in 2023.
Last of the Dodd-Frank Act Regulations. More than a decade after the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC in 2022 adopted final regulations regarding pay versus performance disclosure and compensation clawbacks, marking the last of the compensation-related regulations borne of the 2008 financial crisis.
- Pay versus Performance (PvP). The final rules require annual proxy disclosure of the relationship between executive compensation paid by a registrant and the registrant’s financial performance. Specifically, registrants must provide a table disclosing itemized compensation amounts and financial performance measures for their five most recently completed fiscal years (with the five-year look back phased in during a transition period). Registrants must comply with the new disclosure requirements in proxy and information statements for fiscal years ending on or after December 16, 2022; i.e., for the upcoming 2023 proxy season. For a detailed discussion of the final PvP rules, see our August 29, 2022 memorandum, “SEC Adopts Pay Versus Performance (PvP) Disclosure Rules.”
- Compensation Clawbacks. Under the final rules, an issuer must adopt a policy that requires it, in the event of an accounting restatement, to recover from current and former executive officers incentive compensation that would not have been earned based on the restated results. There is virtually no board discretion under the final rules. In addition to the requirement that issuers adopt a compensation recovery policy, the final rules require disclosure in an issuer’s annual proxy statement if, during the prior fiscal year, either a triggering restatement occurred or any balance of excess incentive-based compensation was outstanding. Based on the timetable established by the Commission, the NYSE and Nasdaq are expected to adopt final listing standards within the next twelve months and issuers will have 60 days thereafter to comply. Now is the time to review existing clawback policies to assess alignment with the SEC requirements. For a detailed discussion of the final clawback rules, see our October 31, 2022 memorandum, “SEC Adopts Final Compensation Clawback Rules.”
Proxy Advisors. Last November, ISS added to its list of problematic pay practices that may result in a negative say-on-pay recommendation “severance payments made when the termination is not clearly disclosed as involuntary.” ISS has historically criticized payment of severance when ISS concludes (whether or not correctly) that the nature of a termination is not a severance qualifying event; the recent guidance raises the profile and significance of 8-K disclosure for NEO separations. Last December, Glass Lewis revised the threshold for the minimum percentage of a long-term incentive grant that should be performance-based from 33% to 50%, and indicated that it will raise concerns with executive pay programs where less than half of an executive’s long-term incentive grant is subject to performance-based vesting conditions. Other than the aforementioned items, neither ISS nor Glass Lewis issued any significant compensation-related policy updates for the 2023 proxy season, though both firms announced voting policy updates in a number of other key areas including board diversity. For a detailed discussion of these updates, see our December 6, 2022 memorandum, “ISS and Glass Lewis Issue Final 2023 U.S. Voting Policies.”
Equity Award Considerations in a Reduced Stock Price Environment. Many issuers experienced significant stock price declines in 2022, especially in the tech sector. These declines should be taken into account by compensation committees as they consider 2023 annual equity grants. A reduction in market value will result in awards covering a larger number of shares and may put pressure on individual and aggregate share limits under a company’s shareholder approved equity plan. If plan limits are insufficient to make ordinary course annual equity grants, companies may consider granting cash-settled awards outside of a shareholder-approved plan in the form of phantom equity or stock appreciation rights; however, cash-settled awards will result in variable, or “mark-to-market,” accounting. Companies seeking approval for new equity plans or new share reserves at their annual meetings may also need to re-calibrate the size of their requests to reflect the reduced value of shares.
Golden Parachute Tax. M&A transactions may expose company employees to the 20% excise tax on golden parachute payments (Section 280G), including the value of equity awards that vest in a transaction and severance payments for executive terminations that occur in connection with an acquisition. The golden parachute tax may significantly reduce the value of compensation that an executive has earned (or will earn in connection with a transaction). Fortunately, it is possible to mitigate the negative impact of Section 280G. Properly implemented non-compete arrangements and acceleration of taxable compensation into the year prior to a transaction closing may eliminate or reduce the adverse effects of the golden parachute tax, though, as noted in our recent memorandum, “FTC Proposes Rule Prohibiting Non-Compete Clauses for Workers,” there is substantial regulatory pressure to limit or eliminate non-competes. The sooner that a company understands the scope of any 280G issues, the longer it has to identify and implement solutions.
Preserving Human Capital. The market for key talent remains robust notwithstanding the economic volatility and inflationary environment. The risk of losing key talent is as high as ever. In a tight labor market with unprecedented flexibility regarding work location, the competition for talent remains intense and may require off-cycle retention awards, especially if downward pressure on stock prices has reduced the retentive value of outstanding equity awards.
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We are independently owned, and have no entangling relationships that may create potential conflict of interest scenarios, or may attract the unwanted scrutiny of regulators, shareholders, the media, or create public outcry. Veritas goes above and beyond to provide unbiased executive compensation counsel. Since we are independently owned, we do our job with utmost objectivity - without any entangling business relationships.
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