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Proxy season 2017: Non-employee director compensation in the spotlight

RFP
Human Capital Bulletin: Proxy season 2017: Non-employee director compensation in the spotlightVoting policy updates
The 2017 proxy season is upon SEC registrants, and while the SEC has not issued any new final rules on previously proposed Dodd-Frank Wall Street Reform and Consumer Protection Act items, companies should be aware of updates to shareholder advisory group voting policies that focus on non-employee director compensation.

Advisory groups’ response
A number of recent high-profile lawsuits regarding excessive non-employee director compensation reflect increasing shareholder scrutiny on the amount, and form in which, non-employee directors are compensated. As a result, companies have started to include advisory proposals seeking shareholder approval of their non-employee director compensation programs.  Shareholder advisory groups, such as Institutional Shareholder Services (ISS) and Glass, Lewis & Co. (Glass Lewis) have updated their voting policies to include a framework to evaluate such proposals.

Grant Thornton insights
The ISS will support, on a case-by-case basis, non-employee director compensation by taking into consideration the following qualitative factors:

  1. The relative magnitude of director compensation as compared with companies of a similar profile
  2. The presence of problematic pay practices relating to director compensation
  3. Director stock ownership guidelines and holding requirements
  4. Equity award vesting schedules
  5. The mix of cash and equity-based compensation
  6. Meaningful limits on director compensation
  7. The availability of retirement benefits or perquisites
  8. The quality of disclosure surrounding director compensation

In addition, ISS will assess the total estimated cost of the company’s non-employee director equity incentive plan, measured using the ISS Shareholder Value Transfer (SVT) test and the company’s three year burn rate, both measured relative to the company’s industry and market cap peers. For these quantitative tests, the ISS will combine the non-employee director equity plan with employee or other executive stock plans. The ISS will support the non-employee director equity incentive plan on a case-by-case basis taking into consideration the qualitative factors provided above, should the non-employee director equity plan exceed the plan cost or burn rate benchmarks when combined with employee or executive stock plans.

Glass Lewis’ policy on non-employee director compensation is not as transparent as the ISS policy. Glass Lewis will consider recommending support of non-employee director compensation plans that include option grants or other equity-based awards that help to align the interests of outside directors with those of shareholders. However, Glass Lewis policy states that equity grants to non-employee directors should not be performance-based. This policy runs counter to market practices regarding executive compensation programs, but we feel it is more aligned with a non-employee director’s role to serve as a check on excessive risk-taking in executive compensation plans.

Call to action
In our experience, a regular review and assessment of non-employee director compensation is not an undertaking in which boards of directors or compensation committees routinely engage, even for those companies that regularly review and assess the compensation of their top executives. However, shareholders and other stakeholders have taken notice of non-employee director compensation, specifically the amount and the form of pay. Because of this attention, compensation committees should undertake the following actions over the next year.

  1. Review non-employee director compensation plans for compliance with applicable tax and other related regulatory matters. Historically, non-employee director compensation plans may not have been reviewed as regularly as employee plans and may not be up to date with recent regulatory changes.
  2. Assess non-employee director compensation against similarly situated companies. Compensation committees should assess the amount and type of compensation offered against the requirements of each board member (number of meetings, number of committees, committee chair versus member, etc.) relative to their peers.
  3. Develop and implement compensation plans that align non-employee directors with their oversight role of the company.  Compensation committees should ensure plans do not encourage excessive risk taking by board members and executives and are aligned with the long-term goals of the company.
  4. Clearly draft a summary of the company’s non-employee director compensation program and how the program is aligned with the company’s long-term goals.  Compensation committee should ensure the summary can be easily understood by shareholders and other stakeholders.

Scrutiny continues
Shareholder advisory groups are beginning to implement frameworks for which to evaluate a public company’s proposal seeking shareholder approval of non-employee director compensation programs.  At this time, shareholder advisory groups will assess non-employee director compensation only when a company introduces a pay plan for approval by shareholders. However, companies should use this as an opportunity to review non-employee director pay to ensure that both the amount and form of pay is appropriate and aligned with the company’s long-term goals.  We anticipate the scrutiny by shareholders and other stakeholders on non-employee director compensation will only increase.

Contact
Eric Myszka
Director, Human Capital Services
T: +1 312 602 8297