Author: ERI

“Control of Pay” vs. “Say on Pay” for British Executives

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Aligning executive pay to performance seems to be at the forefront for boards, shareholders, and legislators. The UK has been ahead of the curve when it comes to regulating executive compensation practices. As early as 1999, they were considering a non-binding Say-On-Pay vote for executive compensation. However, it didn’t become enacted until 2002 when the Directors’ Remuneration Report was introduced, which required companies to submit a remuneration report to a non-binding shareholder vote at each annual general meeting.  Subsequently, UK made amendments to regulate executive contract renewals as well as loss of office (i.e. golden parachute, severances, etc.), and other countries, like the Netherlands and Australia, introduced similar legislation.

Recently, on June 20, 2012, there was an unprecedented proposed legislation in the UK to give the shareholders a “binding” vote for the CEO compensation recommendation.  The main provisions of the proposal follow:

  • Publicly listed companies will need to gain approval of shareholders to award compensation packages to directors in an annual vote, which may be effective as early as 2013.
  • The vote can be limited to once every three years as long as no changes are made to the compensation arrangements.
  • A binding vote will cover the level of exit payments (severances).
  • To improve transparency, companies will be required to disclose a single remuneration figure with a chart comparing the pay recommendation and company performance for each executive.

Let’s take a look at some of the recent events that may have triggered this proposal:

  • Public sentiment regarding the misalignment of the pay recommendation with share performance and pay practices (i.e. freezing or reducing pay of employees while increasing executive pay).
  • The slow economic turnaround in most countries coupled with lack of investor confidence in the markets.
  • Shareholders (especially insurers and large pension funds) are more actively participating in the Say-on-Pay process reviewing the executive pay recommendation.
  • Continued pay for failure practices resulting in excessive exit packages awarded to executives.
  • Highly publicized “No” votes at WPP, Aviva Astra Zeneca, and Trinity Mirror.
  • Shareholder advisory groups, like Institutional Shareholder Services, continue to raise concerns about remuneration practices.

Depending on the outcome of this proposal, other countries may follow suit in proposing similar changes.

For more UK executive compensation data, visit www.erieri.com.

What is Reasonable Compensation for Presidents of Community Colleges?

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After a report that presidents of New Jersey state community colleges were receiving much more than the US average salary of $165,000, New Jersey Governor Chris Christie ordered a follow-up investigation of their compensation in early June.  These salaries are set by the trustees of the individual colleges, as the state of New Jersey ceded control of community colleges in 1994.  Although supported by taxpayer dollars, there are no guidelines for compensation for the top executives and there were huge salary disparities among pay in the state’s nineteen two-year colleges.  With community college tuition rates in New Jersey among the highest in the nation, such high salaries for presidents have warranted a closer look.

The average salary of $165,000 used as the benchmark for the report to the Governor came from a 2009-2010 study of 208 colleges by Yaffe & Co. However, some more information is necessary to determine whether or not the presidential pay ranges are in line – hopefully, that is what the current in-depth study will add.

The IRS says nonprofits must pay employees reasonable compensation, but there are few specific guidelines. In general, total compensation must be compared with what would be paid for like services by like enterprises under like circumstances[1].  Typically, “like” means similar size and industry – in the nonprofit world, this equates to annual revenues and the type of organization.  What is missing in the reported salary levels for New Jersey is the size of the colleges in question, as size is an influential factor for determining appropriate compensation.

ERI Economic Research Institute compiles a database of compensation data reported on the Form 990 for our Nonprofit Comparables Assessor. A quick analysis of the data shows that New Jersey community colleges do seem to pay higher than the national average.  However, whether that New Jersey pay should be a concern for local taxpayers is related to the size of the college in question.

Direct Cash Compensation

Top Position — Community or Junior College — All US

Revenue

25th Percentile

Mean

75th Percentile

75,000,000

167,014

306,031

445,047

50,000,000

147,192

269,709

392,226

25,000,000

118,599

217,317

316,035

10,000,000

89,142

163,342

237,541
Direct Cash Compensation

Top Position — Community or Junior College — New Jersey

Revenue

25th Percentile

Mean

75th Percentile

75,000,000

183,390

317,994

452,597

50,000,000

232,198

284,805

337,411

25,000,000

101,287

235,890

370,494

10,000,000

49,273

183,877

318,480

The missing information about the size of the community colleges in question will indicate whether or not these presidents are paid more than their counterparts across the US, and if they are paid in line with their New Jersey colleagues.

Setting the “right” nonprofit compensation requires data from relevant comparables – those from a similar industry, size, and geography. ERI’s easy-to-use software allows for such comparisons.  Download a free demonstration version of the Nonprofit Comparables Assessor or schedule a Guided Tour for more information on nonprofit compensation data.

Free Compensation White Papers

Posted on | by ERI

ERI is committed to providing compensation professionals with valuable online resources and educational opportunities. Be sure to check out our latest white papers (detailed below) and upcoming webinars.

Also visit our News Room for links to “ERI in the News,” press releases, and quarterly updates. Online compensation and benefits courses are available for continuing education credits through the ERI Distance Learning Center.

IRS and Nonprofits: What Happened in 2011 and What to Expect in 2012

The latest report on the activities and plans for the Ex­empt Organizations (EO) division of the Tax Exempt and Government Entities of the IRS provides some in­sight into what’s ahead for nonprofits – good to know if your nonprofit is in a group targeted for some scrutiny. ERI’s white paper, “IRS and Nonprofits: What Happened in 2011 and What to Expect in 2012,” highlights accomplishments in Fiscal Year (FY) 2011 and previews plans for FY 2012, as outlined by EO Director Lois Lerner.

Underemployment: Implications for Organizations

In addition to unprecedented and persistently high unemployment rates since 2008, employers have been cautious with staffing by hiring more part-time workers. Combined, these factors have given organizations the advantage of attracting top talent in the underutilized and involuntary part-time labor markets. ERI’s white paper, “Underemployment: Implications for Organizations,” provides an analysis of industry sectors and related job losses to examine the composition of the underemployed and details proactive approaches employers might use to sustain the benefits of these market advantages.

Introduction to Skill-Based Pay

Having gained popularity in the early 1990s, skill-based pay plans continue to play important roles as standalone or supplemental compensation systems. General information on the benefits and challenges of instituting skill-based pay, as well as insights on developing a plan, are just some of the topics covered in ERI’s free white paper, “Introduction to Skill-Based Pay.”

Perceived Fairness in Compensation

Numbers on the paycheck aside, how an employee perceives his or her compensation as fair affects your organization. ERI’s new white paper, “Perceived Fairness in Compensation,” outlines potential problems associated with perceptions of fairness within the context of compensation, examines how individuals discern fairness, and provides practical ways to help employees understand how their salaries are set.

Improved Transparency for Charity Executive Pay: A Review of Form 990 Data

Are executives at nonprofits paid reasonably? Debates over compensation in the nonprofit sector are heated and ongoing, often without reference to compensation data that are reported annually to the IRS on Forms 990 filed by most organizations. In our latest white paper, “Improved Transparency for Charity Executive Pay: A Review of Form 990 Data,” ERI addresses the questions that are relevant for the ongoing discussion of unreasonable compensation in the charitable sector.

SEC Investigates Executive Loans

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The U.S. Securities and Exchange Commission has opened an inquiry into Chesapeake Energy Corp’s program that granted Chief Executive Officer Aubrey McClendon a share in each of the natural gas producer’s wells.  It is possible that the arrangement is considered an executive loan to the CEO seeing as McClendon took out as much as $1.1 billion in personal loans by pledging his 2.5% stakes in the energy company’s oil and natural gas wells as collateral.  The loans were made through companies in which McClendon has a controlling interest.  This event has subsequently led to a 5.5% percent decline in the company’s stock from when the first article appeared in the headlines.  Soon after, Chesapeake Energy announced it was ending the investment program that allowed its top executive to borrow and mortgage against personal stakes in company’s wells. Due to the Enron scandal and the subsequent Sarbanes Oxley regulations (SOX), loans to executive officers are banned.

In 2002, Section 402 of the Sarbanes-Oxley Act amended the Securities Exchange Act of 1934 to prohibit all companies with securities traded in the United States from making or arranging for a personal loan to their directors and executive officers.  Some advocates for executive loans argued that they can serve the purpose of financing managerial stock ownership which aligns management and shareholder interest, but the argument hasn’t prevailed in any court of law.  Highlights of the ruling that ban executive loans include the following:

  • Material modifications of grandfathered loans that existed at the time the amendment was enacted are banned.
  • When an executive uses company issued credit cards for personal use and takes cash advances, this may be considered a personal loan.
  • Exemptions are available, the most common being if the executive works for a financial services company and is granted a loan by his/her employer which is made in the ordinary course of consumer credit business and also made available to the public.
  • Although the executive loan rule doesn’t apply to private companies, if said companies plan to go public, such executive loan arrangements need to be terminated prior to going public.
  • Loans to non-executive employees are permitted.
  • Directors and executive officers should minimize using company stock or stock options as collateral for financing arrangements.
  • Transactions in which the same financial institutions providing loans to the company is loaning to the executive as well should be avoided.

There are fines and penalties for individuals and corporations which hinge on the willful or reckless nature of establishing such loans arrangements.  The issue with Chesapeake Energy is the Board communicated that they knew and had knowledge of the financing arrangement, then, soon after, issued another statement that attempted to “recant” the admission.  It may be too soon to tell the outcome of this investigation.  In the meantime, in addition to understanding the SOX rules for executive loans, organizations should review their executives’ financial arrangements with the corporation under their management purview and ensure all arrangements pass the muster of an “arms-length” agreement (i.e., both parties do not have a special relationship or control over one another, and the arrangement results in fair price, conditions, and other terms).

For more information, analytics, and tools related to executive compensation, visit www.erieri.com.

Executive Compensation and Stock Warrant Plans

Executive Compensation and Stock Warrant Plans

Posted on | by ERI

When Rob Johnson took the helm as CEO of JC Penney, his executive compensation package made headlines because he invested his own money in the company by purchasing a warrant valued at almost $50 million.  Warrants are financial instruments that are typically “wrapped” into debt arrangements like bonds, sold to investors to raise cash, and function similar to options.  So, how are warrants structured to be used as a compensation instrument?

CEO Johnson’s warrant has the following characteristics:

  • a 7.5 year term
  • vest date after June 13, 2017
  • entitles him to acquire 7,256,894 shares
  • exercise price of $29.92 per share
  • vests only when market price is greater than $36.81

During ERI’s Q1 2012 data collection efforts for European executive compensation data, we identified a few Danish companies that have “broad-based” stock warrant plans in which both executive and non-executive employees are eligible. One such company is Lundbeck Group.  Their plan allows warrants to be issued up to a nominal value of DKK 8,750,000, equivalent to 1,750,000 shares of DKK 5 each. The awards have a 5-year vesting schedule that hybrid cliff and graded: no vesting in years one and two; 20% in three years; 30% in the fourth year; 50% in the fifth year, and otherwise lapse if not exercised before December 31, 2018.

Some stock warrants are “performance-based” where the grantee has to achieve target goals in order to actually own the warrant.  For example, in order for a warrant of 5,000 shares to vest, the grantee must sell $1,000,000 of product in the next 12 months with a cap of 50,000 shares.

When a warrant is issued as a compensation instrument, how similar is it to employee stock options?  Let’s start with a side-by-side comparison to understand the similarities:

 Warrant  Employee Stock Options*
 Right to buy company shares at a future date and at a pre-agreed price  Same
 Do not have to be tied to employment (or board membership)  Same for non-qualified plan
 Can have a term longer than 10 years  Same for non-qualified plan
 Are dilutive and affect stock values  Same
 Underlying stock is equal to the exercise price, plus any increase in value  Same
 Disclosed in proxy statement  in option awards column  Same
 Not taxable upon grant or issue  Same
 Upon exercise difference between exercise price and the stock’s value is taxed at ordinary income tax rate  Same for non-qualified plan
 *Same = both qualified and non-qualified employee stock option plans unless otherwise  noted

So are warrants “synonymous” with non-qualified stock options?  Technically, the answer is “no.”  In addition to raising funds, companies also issue warrants to control dilution by issuing the warrants to a targeted group of shareholders who may elect to invest more money or lose ownership percentage. When warrants are issued to raise money or control dilution, they are transferable in the open market and do not have restrictions like not vesting or performance triggers.  As a compensation tool, warrants appear to be more versatile and can serve dual purposes, depending on the needs of the organization, whereas employee stock options have more specific requirements.

For more information, analytics, and tools related to executive compensation, visit www.erieri.com.

For Nonprofits, It’s All About the Board

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A recent blog by Lucy Marcus again brings home what being on the Board of a nonprofit means – a responsibility not to be taken lightly!

This lesson for how boards should function comes from an investigation of Greg Mortenson, former executive director of the Central Asia Institute (CAI).  Investigators found that he had used funds for personal use and fabricated the accomplishments of his charity. In April 2012, the attorney general of Montana ordered Mortenson to repay $1 million to CAI and decided that he can no longer serve on the board or hold a position of financial responsibility. While board oversight was conspicuously missing in this situation, Marcus chose to focus on how a Board can be structured to prevent such abuses.

Nonprofit boards exist to ensure that resources go toward the mission of the organization and are used responsibly, whatever the size and mission of the charity. Board members should have expertise in a number of areas:

  • Governance – setting up processes and procedures to keep the organization healthy, to keep the focus on the mission and to use funds responsibly.
  • Financial knowledge – providing oversight and financial planning.
  • Independence – with no ties, adding different views for discussion and oversight.
  • Fundraising – critical, but recognizing that the primary role of the board is governance and ensuring that raised funds are used as intended.
  • Mission/organization-relevant knowledge – adding valuable, and sometimes costly, expertise, such as marketing, human resources, legal advice.

The Exempt Organization of the IRS (the division that regulates charities) agrees that there is a linkage between good governance practices and compliance with IRS rules and regulations.  As noted in a recent post but worth recapping, the preliminary analysis by the IRS showed organizations are more likely to be compliant if they:

  • Have a written mission statement,
  • Always use comparability data when making compensation decisions,
  • Establish procedures for the proper use of charitable assets, and
  • Have the Form 990 reviewed by the entire board of directors.

It is clear that filling out the governance questions on Part IV of the Form 990 is important to the IRS and “wrong” answers in this section (for example, no comparability data used for compensation decisions) could end up leading to a review by the IRS.  It is hard to envision a successful organization that does not have a written mission statement, and procedures to protect assets.  A review of Form 990 by the entire board is easily implemented.  And comparability data are easily available – in fact, ERI’s Nonprofit Assessor, available at www.erieri.com, provides executive salary comparability data at no cost, which is adequate for the vast majority of nonprofits.

So before you accept that invitation to join a nonprofit board, make sure you understand the necessary commitment and are ready to accept the responsibility.

Does Nonprofit “Good Governance” Lead to IRS Tax Compliance?

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The Exempt Organizations division of the IRS thinks so, and has some preliminary evidence to back up the assertion.  In a recent speech, EO Director Lois Lerner disclosed some current research results and plans for a more comprehensive look at the link between organizations that are well governed and their likeliness to be compliant with tax law.

For the past few years, all IRS compliance checks included a check sheet on governance practices for the organization.  Obviously, the roughly 1,300 organizations in this group had already been selected for a check for reasons unrelated to governance, so it is not a statistically representative sample of nonprofits.  But the analysis of some key data points shows interesting results.

Organizations are more likely to be compliant if they:

  • Have a written mission statement,
  • Always use comparability data when making compensation decisions,
  • Establish procedures for the proper use of charitable assets, and
  • Have the Form 990 reviewed by the entire board of directors.

This initial analysis covers only 501(c)(3) public charities that were already selected for exam based on other criteria, but, according to Lerner, does provide some possible indicators of tax compliance.  And now an IRS strategic planning group is developing a proposal to expand the data analysis to a statistically representative sample of all nonprofits.  The IRS hopes to have the data to support its premise that good governance leads to good tax compliance.

In the meantime, filling out the governance questions on Part IV of the Form 990 is important to the IRS, and “wrong” answers in this section (for example, no comparability data used for compensation decisions) could end up leading to a review.  It is hard to envision a successful organization that does not have a written mission statement and procedures to protect assets.  A review of the Form 990 by the entire board is easily implemented.  Even comparability data are easily available — the demonstration version of ERI’s Nonprofit Assessor, available at www.erieri.com, provides executive salary comparability data at no cost, which is adequate for the vast majority of nonprofits; larger organizations may want to purchase the Professional version which provides more detailed information. This is the same software used by IRS to check compensation levels; nonprofits can view the same analysis as the IRS compliance staff.

The IRS is always looking for ways to identify efficient ways to use its limited compliance resources.  Nonprofits may not only improve their chances of success, but also lessen the probability of an IRS investigation by implementing some simple good governance practices.

Citigroup’s Shareholders Vote “No” on Executive Compensation

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Citigroup’s shareholders recently voted “No” to CEO Vikram S. Pandit’s $14.85 million in compensation. Although the bank’s 2011 net income was $11.1 billion, a 4.4% increase over 2010, Citi garnered a mere 45% approval for the executive compensation recommendations. Looking at the total compensation of some of the direct competitor peers for the same period shown below, CEO Pandit’s package doesn’t seem unreasonable.

  • American Express K.I. Chenault $23.03 million
  • Bank of America Brian T. Moynihan $8.08 million
  • Goldman Sachs Lloyd C. Blankfein $14.11 million
  • JP Morgan Chase James Dimon $23.10 million
  • Wells Fargo John Stumpf $19.84 million

Let’s take a deeper look into what may have triggered the “No” vote.

  • The day before the 2012 shareholders’ meeting, Citigroup posted a 2% net income decrease for the first quarter compared to first quarter 2011.
  • As of March 2012, Citi may have to pay a $285 million penalty pending final court rulings. Citigroup is charged with misleading investors in a $1 billion derivative deal tied to the housing market and then betting against investors when there were signs of distress. Citi profited $160 million, while investors lost $700 million.
  • Also in March 2012, the Federal Reserve stopped the company from paying higher dividends on the basis that Citi wasn’t financially strong enough. This decision came after CEO Pandit announced a commitment to raise dividends.
  • Institutional Shareholder Services (ISS) recommended that investors vote against Citi’s compensation package primarily because Pandit’s retention pay ($40 million potential value in equity awards over a three-year period) was not linked to any financial metrics.
  • Citi’s stock price is currently hovering at $35/share, whereas in pre-financial crisis (before 2008) stock price was closer to $45/share.

In light of some of these factors, the “No” vote doesn’t come as a surprise. Citigroup’s board is planning to reach out to key shareholders in an effort to better understand the reasons for the negative vote, which, in turn, may affect changes in the compensation recommendation moving forward.

Health Care Benefits Survey Shows Employers Struggling to Reduce Costs

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Employers throughout the United States are continuing to implement less costly health care options because of rising medical costs. Rather than offering changes in traditional plans, many employers are moving to High Deductible Health Plans coupled with a Health Savings Account. Others are simply reducing benefit levels by increasing employee contributions, deductibles, co-payments, coinsurance, and out-of-pocket maximums.

 

The new 2012 Health Care Benefits Benchmarking Survey, released April 2, 2012, by ERI Salary Surveys, confirms the trend to shift more costs to employees. The report details data submissions from 163 employers representing more than 160,000 employees. Data are reported for 330 medical plans and 185 dental plans in the U.S., all effective January 2012. The information provides employers with a baseline of current health plan costs and practices that may be used to make informed decisions regarding benefits management.

 

Here are some highlights of the survey:

 

Provision of Medical Benefits

  • Preferred Provider Organization (PPO) plans continue to dominate the market, enrolling 59% of the covered employees in the United States.
  • Participation in High Deductible Health Plans (HDHP) combined with a Health Savings Account (HSA) has increased dramatically since 2009. For 2012, total response for such plans ranked third behind PPOs and Health Maintenance Organization (HMO) plans, respectively.
  • Enrollment in Indemnity and Point of Service (POS) plans continue to decline.

Cost of Medical Benefits through PPOs

  • Average monthly employee cost for employee-only coverage is $130.90, up 2% from last year.
  • For employers, the average monthly cost for employee-only coverage dipped 5 percent to $397.29, but still represents three-quarters of the total premium cost.

Dental/Vision Coverage

  • Dental benefits are offered by 91% of responding organizations. Within those organizations, 62% of the employees enrolled.
  • Vision benefits are offered by 85% of respondents; 67% contribute to the cost.

 

In addition to providing details on the findings listed above, the fifth annual Health Care Benefits Benchmarking Survey also reports information on the length of employment requirements for coverage, cost-management strategies (such as disease management, health promotion, and wellness programs), as well as breakouts by size and type of employer and geographic location. The survey is available online for $289 via http://salary-surveys.erieri.com. For more information, contact ERI Salary Surveys at (800) 627-3697.

 

For those interested specifically in benefits for nonprofits, the 2012 Benefits in Nonprofit Organizations, 12th Edition, will be available from ERI Salary Surveys in July 2012.

Whither Form 990 E-filing – or Is It Wither?

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If you have ever wondered why nonprofit issues and compliance do not appear to be top priorities with the IRS, just review the statistics presented in an article in the most recent issue of the Statistics of Income (SOI) Bulletin – Winter 2012, published quarterly by the SOI, the research division of the IRS.
Brett Collins, author of Projections of Federal Tax Return Filings: Calendar Years 2011–2018, estimates that about 237 million tax returns are expected to be filed in 2011 – of these, about 741,000 will be Forms 990, 990-EZ, and 990-PF. Thus, not only is there very little money to be gained in working on nonprofit compliance, but the 990 series represents only about 0.3% of the total returns filed. Another 480,000 organizations will file the electronic post card, the 990-N – these are the very smallest entities with less than $50,000 in annual revenues.
Now about 77% of all individual income tax returns are e-filed, and that is projected to rise to 84% in 2018. When e-filing reaches these levels, the processing of the data is less of a burden for the IRS.
While the IRS tries to manage its ever increasing work of processing data by encouraging (and requiring where possible) e-filing of returns, the expectations are discouraging for the nonprofit sector. The number of Forms 990, 990-EZ, and 990-PF filed in 2018 is projected to increase by about 14% from 2011. The percentage of e-filing is expected to rise also, but only to 38%, not nearly the level for individual tax returns (84% in 2018), or corporation returns (55% in 2018). The table below breaks out the estimates by type of return.
Type of Return
Estimated 2011
Projected 2018
Total Forms 990, EZ, PF
741,200
842,600
990, EZ, PF e-filed
203,100
321,500
% of total e-filed
27%
38%
Total Form 990
401,700
448,100
990, e-filed
113,900
175,500
% of total e-filed
28%
39%
Total Form 990-EZ
222,500
264,500
990-EZ, e-filed
73,600
114,200
% of total e-filed
33%
43%
Total Form 990-PF
117,000
130,000
990-PF, e-filed
15,600
31,800
% of total e-filed
13%
24%
The Forms 990 now serve as the major public source of information about an organization’s finances, governance, operations, and programs for federal regulators, the public, and many state charity officials. Supported by nonprofit sector groups such as Independent Sector (see https://www.independentsector.org/efiling_form_990?s), e-filing actually promotes accurate Forms 990 as the preparation software detects incomplete and potentially inaccurate information before returns are filed. It also allows the IRS to provide immediate feedback to organizations about incomplete returns and those with obvious inaccuracies.
The IRS currently requires larger organizations – with assets of more than $10 million – to e-file if they filed more than 250 returns (including W-2s and other returns). Private foundations that file at least 250 returns are also required to e-file Form 990-PF, regardless of total assets. And, of course, the five-question Form 990-N postcard is available only electronically, and must be e-filed by the very smallest organizations in the sector. The vast majority of the nonprofits are not required to e-file – software is used to prepare their returns, then they are printed and mailed to the IRS, where they are scanned and turned into images for distribution, a time consuming and expensive process that does not result in data usable for research.
The impediment to requiring e-filing for all is a provision in federal legislation from 30 years ago designed to reduce filing burdens for smaller entities, not just nonprofits. However, with the dramatic change in how computers are used from the 1980s to the present, e-filing for all organizations is not a burden and is generally supported in the nonprofit sector.
Making this necessary legislative change to require organizations to e-file should be a priority for all those interested in the nonprofit sector. Because of the limited resources of the division of the IRS in charge of the nonprofit filings, the forms were deemed to be public, thus allowing all stakeholders – the media, watchdog groups, funders, etc. – to be part of the enforcement process. But, when there is a long delay in providing these public documents and they are in a format that is difficult to use, the purpose of making them public is not met. Making e-filing a requirement would allow the IRS to use its resources more effectively and encourage the creation of a system to disseminate the data in a usable format in a timely fashion.