Fourth Edition
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Library of Congress Cataloging-in-Publication Data
Reda, James F.
The compensation committee handbook / James F. Reda, Stewart Reifler, Michael L. Stevens.—Fourth edition.
pages cm
Includes bibliographical references.
ISBN 978-1-118-37061-2 (hardback)—ISBN 978-1-118-42083-6 (ebk)—ISBN 978-1-118-41718-8 (ebk) 1. Compensation management—United States—Handbooks, manuals, etc. 2. Wages—Law and legislation—United States—Handbooks, manuals, etc. I. Reifler, Stewart. II. Stevens, Michael L. III. Title.
HF5549.5.C67R435 2014
658.3′2—dc23
2013046693
Not too long ago, the general consensus among independent directors was that the chairman of the audit committee had the most challenging position in the boardroom, and audit committee members had the hardest jobs. That consensus has unraveled as, post–Sarbanes Oxley, the necessary and appropriate audit committee tasks have become more generally agreed to and committee member qualifications more demanding. Boards have generally, as well, upgraded the quality of their audit committee membership. Furthermore, audit committee work—while subject to the usual changes from time to time—has not undergone the upheavals common in the past in the audit world.
Now, in the aftermath of the financial meltdown of 2008 and enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, the compensation committee chair is now widely considered the most difficult role on the board, and compensation committee members the least envied by their fellow directors. One reason is that the compensation committee chair and committee members may often find themselves in a difficult tug-of-war with management on pay matters. In the worldwide hunt for executive talent, the compensation committee needs to be vigilant in assuring that management is adequately compensated (though far fewer CEOs change employers due to tough compensation requirements than compensation committees sometimes fear). But as trustees or fiduciaries for the shareholders, the first task of the compensation committee is to get the best management and the best business results at the least compensation cost to the shareholders. Managements, conversely, for themselves and their families, seek the highest pay they can get. As a result, and inevitably, compensation committees and managements can—and should—at least start out with different points of view when approaching executive compensation issues. If the compensation committee is performing its job for the shareholders, it must, at some point, tell management “no.” That is no fun even if management is not performing at a high level; it is tougher by far if management is doing well. This proper and necessary back-and-forth between the compensation committee and management can make compensation committee meetings stressful and unhappy events for committee members.
Another reason why the compensation committee's task is challenging is that there are few roadmaps for deciding what compensation is “right.” Audit committee members can at least refer to voluminous and detailed (though often ambiguous) formal rules stating how books and records should be kept and how transactions should be accounted for. There is, however, no equivalent body of “generally accepted compensation principles” to guide the work of the compensation committee. While nearly everyone can agree on compensation truths at a very high level of generality— “pay for performance,” for example—application of that bromide to a specific company at a specific time in its history and with a particular management in place is another matter entirely. Not only are there few concrete guideposts in reaching pay decisions, there are no compensation police to curb the wilder inclinations of the compensation outliers. The work of audit committees and audit firms is overseen by the Public Company Accounting Oversight Board and the Securities and Exchange Commission at the federal level; in contrast, no one in particular has the legal responsibility to oversee compensation committees or the compensation consultants on which compensation committees have come to so heavily rely. Without firm principles to guide them, compensation committees are at hazard of drifting into some very muddy waters.
If this is not enough to make the compensation committee's job hard, public attention to compensation issues has continued to increase—from shareholders legitimately concerned about pay levels and practices and special interest groups using compensation matters to hide other agendas, to the sensationalistic business and general media and politicians eager to score easy points with their constituents, to self-appointed guardians of politically correct pay. Even compensation committees made up of hardworking, thoughtful board members who understand their responsibilities can find themselves on the wrong end of an ugly controversy about pay decisions.
The consequences of bad compensation decisions can be severe. They range from ill-advised legislative initiatives to shareholder revolts. How should directors who want to do the right thing with executive pay proceed? While there are no guarantees of a trouble-free compensation result, several rules are preeminent for those on or considering joining a compensation committee:
Though we have little hard data, my guess would be that nearly every recent public company compensation mess leads back to committee members who were too eager to please management, too unwilling to challenge the assumptions underlying compensation plans, too busy with their BlackBerries, or too distracted by other obligations to delve into the details of compensation plans, and too careless with the shareholders’ money. Though the vast majority of compensation committees appear to be made up of intelligent and hardworking directors, a minority of compensation committees that don't perform their jobs reasonably end up attracting negative public comment and adverse shareholder reaction to all compensation committees. The resulting counterproductive legislative and ill-thought-through activist compensation agendas harm all public corporations by limiting their flexibility and distracting them from more urgent tasks at hand.
Which brings us to this Handbook. It is designed to help the compensation committee member understand his or her duties and roles, and to remind him or her of both the general and the technical determinants of good compensation committee decision making. No compensation committee will make the right decisions all the time, but a good compensation committee should make the right decisions on average over the long term, and should always make sensible and defensible decisions, even if in hindsight they may appear to be disadvantageous. This Handbook will help willing compensation committee members end up at the right place. It will make good compensation committees better and will help the rest catch up.
Philip R. Lochner, Jr.
Philip R. Lochner, Jr.
Philip R. Lochner, Jr. is a former commissioner of the U.S. Securities and Exchange Commission. He serves or has served on the boards of directors and compensation committees of a variety of public companies, including Adelphia Communications Corporation; Apria Healthcare Group, Inc.; Brooklyn Bancorp; CLARCOR, Inc.; CMS Energy Corporation; Crane Co.; GTech Holdings, Inc.; Monster Worldwide, Inc.; and Solutia, Inc. He has also served as a member of the Board of Governors of the National Association of Securities Dealers and of the American Stock Exchange, as a member of the Legal Advisory Committee of the New York Stock Exchange, and as a member of the boards of directors of the National Association of Corporate Directors. Prior to his retirement, he was vice president, general counsel, and secretary of Time Incorporated and later was senior vice president and chief administrative officer of Time Warner, Inc.
Concern about executive pay is hardly a new phenomenon. Historically, it has tended to ebb and flow with overall economic conditions. Attention tends to decline in periods of economic plenty—as long as most Americans perceive themselves as doing well, they worry less that chief executive officers (CEOs) might be doing better still. Likewise, as general economic fortunes subside, the relatively large earnings of corporate leaders invoke public ire.
Executive compensation “controversies” are not unique to the 21st century and can be traced back to the days of the corporate robber barons. But most people see the modern trend beginning during the recession of the early 1980s when Congress enacted the golden parachute tax law. After a booming economy at the end of the 1980s, scrutiny was again focused on executive compensation during the 1991–1992 recession, resulting in the enactment of new tax, disclosure, and accounting rules. Then, at the end of the bull market of the 1990s, the pendulum once more swung from an attitude of “anything goes” to widespread negative attention again focused on executive pay. Adding to the sense of public distrust was the round of high-profile corporate failures and fraud that took place in the early 2000s, resulting in the enactment of the Sarbanes-Oxley Act of 2002. This was followed by another period of robust domestic economy, with the Dow Jones Average ascending to historic highs. But this led only to the financial meltdown of 2008, which became the worst economic crisis since the Great Depression, and which resulted in the enactment of the Dodd-Frank Act of 2010.
Sarbanes-Oxley, along with the establishment of the Public Company Accounting Oversight Board and new rules from the stock exchanges, responded to the notorious corporate failures by focusing on measures that make it more difficult for corporate officers to commit fraud and that strengthen the ability of corporate boards to detect misconduct. New accounting rules requiring expensing of stock options, an expansive principles-based compensation disclosure regime, a new overlay of laws regulating deferred compensation, and a push for various Say on Pay proposals round out the corporate reforms started in the early 2000s. Then, Dodd-Frank codified Say on Pay voting and required clawback policies, compensation committee independence, hedging and pledging policies, and even a CEO-to-employee pay ratio disclosure. Between 2002 and 2010, the crosshairs seem to have shifted from the audit committee to the compensation committee. In fact, many say that what Sarbanes-Oxley did to the audit committee, Dodd-Frank is now doing to the compensation committee.
Even after Dodd-Frank, public policy makers, public and private oversight bodies, and shareholder groups continue to focus on enhancing the ability of corporate boards of directors to ensure that businesses operate ethically and effectively. The Conference Board, the National Association of Corporate Directors, the Society of Corporate Secretaries and Governance Professionals, the Business Roundtable, the Council of Institutional Investors, and a variety of institutional shareholders and institutional investor advisory groups continue to provide comments and leadership on issues of executive compensation and the role of the compensation committee. Furthermore, there are many major U.S. public corporations that have contributed to the good-governance movement and have themselves provided leadership in this area. We rely substantially on this leadership to provide the best-practice guidance throughout this Handbook. While recognizing that there is no single “correct” model for executive pay that will fit every business organization, there is an identifiable set of evolving best practices that compensation committees and boards of directors can apply. The practices discussed in this new edition reflect current and pending regulations, including new rules by the Securities and Exchange Commission, the Internal Revenue Service, the Financial Accounting Standards Board, the New York Stock Exchange, and the NASDAQ Stock Market. They also reflect the experience of compensation committee members and the knowledge gained in careers as business executives, government officials, corporate board members, governance experts, compensation consultants, and academics engaged in the study of business history and practices. Our hope is that this Handbook will stimulate useful and vigorous dialogue within compensation committees and boards of directors on valid measurements of executive performance, the appropriate level of compensation, and the proper mix of compensation elements and incentives, including base pay, performance bonuses, equity grants, retirement benefits, welfare benefits, perquisites, and other benefits.
We also hope that the best practices identified in this Handbook will encourage compensation committees to establish a set of values that guides compensation discussions. This process should include identifying the goals that the pay package is designed to achieve, carefully examining each element of compensation, and considering the potential costs of the package in a variety of scenarios. Our fundamental point is that every company should have a compensation system based on a core set of clearly established principles, not one based on ad hoc decision making. However, more important than any best practice is the attitude and rigor that the compensation committee brings to its task. What is needed most is courage, leadership, and a spirit of independence—the willingness to ask uncomfortable questions, test the assumptions that underlie traditional past practices, strengthen accepted practices that work, say no when the situation warrants, and chart new courses when the rationale for old habits falls short. These characteristics, combined with the best practices discussed in this Handbook, will ensure best-in-class performance for compensation committees.
Each of the authors would like to thank certain individuals who contributed to this fourth edition of the Compensation Committee Handbook.
Jim Reda thanks his wife, Deborah Reda, who has supported him in every way over the past 22 years; as well as Stewart Reifler, who agreed to revise the second, third, and fourth editions of this Handbook; Laura Thatcher, who helped revise the second and third editions; and now Mike Stevens, who has helped revise the fourth edition. He would also like to thank outstanding directors and compensation committee chairs such as Burl Osborne and William H. Gray III, who passed away in 2012 and 2013 respectively, and made corporate America a better place with their time and energy in designing and implementing shareholder-friendly performance plans that encourage outstanding corporate performance. The knowledge gained in working with these outstanding directors is the basis of this Handbook and his consulting practice. Finally, he would like to thank Molly Kyle for her paramount assistance in reviewing and editing four chapters and working with him and other authors in the process of revising the Handbook.
Stewart Reifler expresses his appreciation to all of the boards of directors, compensation committees, chief executive officers, chief operating officers, chief financial officers, general counsels, senior human resource executives, and other executives whom he has advised over his many years of practice and who have indirectly but immeasurably contributed to this book. In addition, he wishes to thank the executive compensation attorneys at Vedder Price who have all—in one way or another—directly affected the observations, commentary, analysis, and substance of this book. Finally, he would like to thank Alan Nadel and Kevin Hassan for their input on Chapter 9 and Jessica Winski and Allegra Wiles for their time and attention spent in meticulously reviewing selected chapters of this Handbook.
Mike Stevens thanks his wife and kids for their love and support and his colleagues at Alston & Bird for their inspiration and good humor. Special thanks go to Kyle Woods and Stacy Clark for their invaluable assistance in reviewing and improving portions of this book. Finally, he acknowledges with appreciation Laura Thatcher, a friend and mentor for over 20 years, for her guidance and her amazing work on prior editions of the Handbook.
Finally, the authors want to thank Tim Burgard, Helen Cho, and Natasha Andrews-Noel at John Wiley & Sons for all of his time and effort in making possible the fourth edition of this Handbook.
Managing Director, Executive Compensation Consulting
Arthur J. Gallagher & Co. | Human Resources Consulting Practice
Mr. Reda has served for more than 26 years as advisor to the top managements and boards of major corporations in the United States and abroad in matters of executive compensation, performance, organization, and corporate governance. Mr. Reda has played an integral role in the field of executive compensation and the formation of the role of the compensation committee. As a recognized authority on corporate governance, he also serves as expert witness in executive compensation litigation and is typically retained by compensation committees as an outside independent advisor. Mr. Reda has a BS in industrial engineering from Columbia University, and an SM in management from Massachusetts Institute of Technology, Sloan School of Management. He is a member of the Society of Corporate Secretaries and Governance Professionals; WorldatWork; the National Association of Stock Plan Professionals; the National Association of Corporate Directors (NACD); and the New York Society of Security Analysts, for which he serves on the corporate governance committee. He is past chair of the Atlanta Chapter of NACD and was a commissioner member of the NACD Blue Ribbon Commission entitled “Executive Compensation and the Role of the Compensation Committee.” He was also a member of the Conference Board Task Force on Executive Compensation.
STEWART REIFLER
Shareholder, Vedder Price PC
Stewart Reifler is a shareholder of Vedder Price and heads its executive compensation practice in New York City. He has extensive experience in representing companies, their boards and compensation committees, and senior executives, both as an attorney with Vedder Price and formerly with Weil, Gotshal & Manges and the Law Offices of Joseph E. Bachelder and formerly as a compensation consultant with PricewaterhouseCoopers. He has been quoted in BusinessWeek, Fortune, Wall Street Journal, Journal of Accountancy, International Tax Review, and Practical Accountant, and he is a frequent speaker on executive compensation topics. His articles have appeared in National Law Journal, Metropolitan Corporate Counsel, The Tax Executive, Journal of Compensation and Benefits, Mergers and Acquisitions, Director's Monthly, Directors & Boards, Securities Regulatory Update, Corporate Business Taxation Monthly, Estate Tax Planning Advisor, and Journal of Taxation of Employee Benefits. He is a member of the Advisory Board of Corporate Business Taxation Monthly and Compensation Standards.com Executive Compensation Task Force.
MICHAEL L. STEVENS
Partner, Alston & Bird LLP
Mike Stevens is a partner in Alston & Bird LLP's executive compensation practice. He represents companies, executives, and compensation committees in matters relating to executive compensation, with a particular emphasis on tax, securities, and corporate governance issues. Mr. Stevens frequently advises clients with respect to executive compensation issues relating to mergers and acquisitions and other corporate transactions. He has served on the faculty of the Institute of Applied Management and Law and has spoken for numerous organizations, including the National Association of Stock Plan Professionals, the National Center for Employee Ownership, the Society of Corporate Secretaries and Governance Professionals, and the National Investor Relations Institute. Mr. Stevens received his JD, with distinction, from Emory University School of Law in 1993, where he was an editor of the Emory Law Journal; was elected to the Order of the Coif; and received the Lexis Excellence in Writing Award. He received his undergraduate degree, with high honors, from Emory University in 1990. Mr. Stevens is listed in the 2014 edition of The Best Lawyers in America.