Boards Should Expect Greater Scrutiny On Pay

Corporate boards may want to re-evaluate their current compensation models to make sure that they don’t unfairly enrich executives who are responsible for long-term shareholder value.

The shareholder rejection of Electronic Arts’ compensation plan earlier this month is a not-so-subtle reminder that compensation models will be under much heavier scrutiny this year because of complications caused by the Covid-19 pandemic. With so many companies suffering losses in stock price value, filing for bankruptcy and laying-off employees, shareholders will be extremely interested to see how “pay-for-performance” models compensate key executives and board members. Corporate boards may want to re-evaluate their current compensation models to make sure that they don’t unfairly enrich executives who are responsible for long-term shareholder value.

In the case of Electronic Arts, several shareholder groups objected to what they saw as excessive increases in compensation that they didn’t believe were tied to the creation of long-term shareholder value. Although the company reported 2nd quarter total net revenues of $1.46 billion – a $260 million increase over the same period in 2019, many took issue with the proposed increases to several EA executive’s compensation.

The current compensation proposal, which includes salary, stock awards and other compensation, calls for a 16.7 percent raise for the gaming company’s CEO – up from $18.3 million in 2019 to $21.37 million in 2020.  The proposal would also raise the compensation of the CFO 107.4 percent, from $9.41 million to $19.5 million; the CTO would get a 104.3 percent raise, up from $6.95 million to $14.2 million and the Chief Studios Officer would get a whopping 131.6 percent increase, from $6.95 million to $16.1 million.

Since 2007 when the “Say-on-Pay” provision was first established, shareholders have approved company compensation proposals by an average of more than 90 percent each. However, 74 percent of EA shareholders voted against granting the massive compensation increases called for in the current compensation plan. Rejections of compensation plans are rare, but experts are projecting that shareholders will reject a record percentage of compensation plans this year. A Harvard Business School study suggests that shareholder activists may be trying to block compensation in order to force specific governance changes or other management concessions. This tactic may not work because the Say-on-Pay votes are non-binding.

Unfortunately, any time a Say-on-Pay vote fails it implies something isn’t quite right about the company’s governance. The board will need to immediately address the matter with shareholders, and those conversations could be quite contentious. Since the board has fiduciary responsibilities to shareholders, the last thing directors need is a fight over compensation.

Review and improve your pay plan. It never hurts to be proactive. Reviewing how executive compensation is calculated gives the company opportunities to make revisions that can address areas of governance that deserve attention. For example, with the current movement toward diversity in corporate workforces, perhaps an incentive to increase diversity could be added to the compensation plan that will improve governance and overall corporate productivity. Additionally, with pressure to publicize the company’s CEO pay ratio, many companies may find that they need to adjust their compensation plans based on those findings.

Test your plan against a worse-case scenario. How your pay plan performs during a down period is a good indicator of fairness. Many executives pledged to cut their compensation this year because of the COVID-19 pandemic. If the compensation plan is working properly, maybe the plan would compensate appropriately for any downturn without executives having to make a pledge. Companies can also test how generous their pay plan is in good times. There are consulting companies that can help with these types of calculations if executives want to keep the process unbiased.

Be prepared to adjust your compensation plan. If your executive compensation is far higher than the peers in your industry or the percentage increases far exceed what other companies are granting, outstanding performance may be the only defense—in which case, the pay plan would likely have gotten a passing vote. While Say-on-Pay votes are non-binding, pushing for outsized pay will almost certainly result in shareholder actions against the board.