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CURRENT TRENDS IN EXECUTIVE COMPENSATION Robert L. Musick, Jr. J.D. , University of Virginia PowerPoint Presentation
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CURRENT TRENDS IN EXECUTIVE COMPENSATION Robert L. Musick, Jr. J.D. , University of Virginia M.L.T, William and Mary. Your Strategic HR Partner. Background—Executive compensation run amok!.

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CURRENT TRENDS IN EXECUTIVE COMPENSATION

Robert L. Musick, Jr.

J.D. , University of Virginia

M.L.T, William and Mary

Your Strategic HR Partner

slide2

Background—Executive compensation run amok!

  • To 'run amok' is to behave in a wild or unruly manner. 'Run amok' is now synonymous with the term 'go crazy', but originally meant 'a murderous frenzy or rage'. (the Phrase Finder)
  • In the beginning, Enron…2001
  • Other dishonorable mentions—Tyco, Adelphia, WorldCom
  • Reaction to perceived abuses
    • “Cooking the books” begets “Sox”
    • “Free” stock options result in accounting change
    • Nonqualified deferred compensation and the “haircut” cash-out lead to Section 409A
  • At the core, deceptive business practices were the problem, but egregious compensation abuses attracted special attention.
slide3

Good Governance—Who is responsible?

  • Sarbanes-Oxley Act of 2002 addressed many issues, including:
    • Boardroom inattention: Corporate failures pointed to Board members who either did not exercise their responsibilities or did not have the expertise to understand the complexities of the businesses. In many cases, Audit Committee members were not truly independent of management.
    • Executive compensation: Stock option and bonus practices, combined with volatility in stock prices for even small earnings "misses," resulted in pressures to manage earnings. In addition, stock options were not treated as an expense by companies, encouraging this form of compensation.
slide4

Good Governance—Who is responsible?

  • Securities Exchange Commission
    • Enhanced disclosure—detailed tables of various types of compensation
    • Requirement of the Compensation Discussion and Analysis—the company’s executive compensation “story”
    • Responsibility of the Compensation Committee—certification required
  • Nonqualified deferred compensation reform – Section 409A
    • Effective for 2005
    • Strict rules as to time of election/time of payment
    • No more “haircuts” and early distributions
  • Accounting for stock options – FAS 123(R)
    • Effective for 2006
    • Options must be reported as compensation expense over service period
slide5

Good Governance—Who is responsible?

  • Financial meltdown 2008-09 results in Troubled Asset Relief Program (TARP)
    • Executive compensation caps as a condition to receiving aid
      • $500,000 limit on compensation
      • No bonuses
      • Restricted stock only (no options), vesting when TARP money repaid
      • “Clawbacks” for incentives awarded on erroneous financial data
    • Certification of risk analysis by Compensation Committee
    • Non-binding shareholder vote (“Say on Pay”)
  • Dodd-Frank Act of 2010—massive new regulatory impact on financial and other public companies
    • Comparing company performance with executive compensation
    • Comparing chief executive compensation with median employee compensation (“internal pay equity”)
    • “Clawbacks” for incentives awarded on erroneous financial data
    • “Say on Pay” and “Say on Golden Parachutes” advisory shareholder votes
slide6

Major Trends Emerge

  • Board accountability/Committee responsibility
  • Review and retrenchment generally
  • Re-thinking “Pay for Performance”
  • Trickle-down Effect
slide7

Prudent Process—An Overview of Compensation

Committee Procedures

  • Independence—those who oversee executive compensation must be independent of the executives themselves
  • Tally sheet—committee must see and understand the value of “total compensation” (fixed and variable, short- and long-term, cash and stock, current and deferred) for executives
  • Market data/analysis—what are similarly situated companies doing? How are they performing?
  • Executive compensation philosophy—how does the executive compensation structure connect with the company’s business strategy? How much compensation is fixed, variable, performance-driven, etc.
  • Aligning with shareholder interests—does pay link to shareholder value?
slide8

Balancing Reward Against Risk—A Lesson Learned

but Forgotten from Enron!

  • Variable incentives drive behavior—is it clear that “good” behavior benefits the company in the long run?
  • Risks are associated with most types of incentives—what are they?
  • Risk mitigation is necessary to protect the company—how do we do that?
    • Focus on “team goals” that assure individual income depends upon the company’s success
    • “Clawbacks”—recovering incentives paid on the basis of bad data
    • “Holdbacks”—delaying payment of earned incentives to be sure risk to the company has passed
slide9

The cost of compliance is still undetermined, as are the benefits.

  • Do stronger rules produce better conduct?
  • Expect continued close scrutiny of executive compensation process.

The Way Ahead—“Reform” run amok?

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