Equilar Institute

Ask the Experts

What will be the biggest risk boards must address for 2019?

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Michael Brittian has consulted since 2000 on executive and director compensation issues, including incentive program design, market data analysis, compensation strategy and philosophy, governance best practices, executive severance arrangements, technical issues and program implementation. He advises both public and private companies ranging from S&P 500 companies to pre-IPO startups. He has diverse industry expertise, including oil and gas, financial services, retail and transportation. Mr. Brittian co-leads Meridian’s Market Data Intelligence team, tasked with keeping Meridian current on all compensation market data-related sources and developments. He serves on the Board of Directors of the Perot Museum of Nature & Science and the advisory Board of Directors of the NACD’s North Texas Chapter. He began his career as a consultant with Hewitt Associates.

A retail CEO resigns due to health issues. The CEO of a large technology _rm is terminated due to violating the company’s code of conduct policy. The CEO of a well-known restaurant group resigns after making controversial public comments on social issues. A large name-brand company loses their CEO to a competitor.

These headlines seem to be increasingly common, putting corporate boards even more in the spotlight for decisions on leadership selection, succession planning and their handling of CEO turnover. So far this year, Equilar has tracked 44 CEO departures among large-cap companies through August 1, and an article from MarketWatch.com from February 2018 stated that CEO turnover has reached its highest level in eight years. A review of the circumstances surrounding these departures suggests that many were sudden or unexpected.

Any CEO transition is a complicated and sensitive task for a board, but when the transition is unplanned, this can pose a significant risk to companies and boards. Already we’ve seen situations where CEO turnover (and the circumstances leading up to the CEO’s departure) can have the following effects:

• Disruptions in business operations

• Negative stock price impact

• Uncertainty on timing of new permanent CEO leadership

• Further unwanted turnover and retention risk among executive ranks

• Reputational impact to the company and its directors

As CEO turnover may continue at the current pace into 2019, boards can take action now to prepare for an unexpected CEO change.

Review succession planning through the lens of an unexpected CEO change and develop an action plan. Some companies may already have an internal candidate ready to take the reins; however, many companies must rely on interim leadership until a permanent CEO can be installed. If not already in place, develop an emergency CEO succession plan considering various potential scenarios.

Update the CEO tally sheet more regularly. By now, most boards review a total compensation tally sheet, including “walk away” pay scenarios, for the CEO annually. Boards should consider whether a more frequent review is appropriate to maintain current estimates in case of an unexpected CEO departure.

Analyze management retention hooks. CEO turnover can create insecurity among management team members and increase retention risk. Boards should be regularly monitoring a “glue” analysis of the holding power of unvested equity awards and other compensation and benefit programs to ensure the proper hooks are in place to retain key management team members in periods of uncertainty.

Unexpected CEO turnover can pose significant risks to boards, but there are ways to potentially mitigate these risks with some advanced planning.

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Joseph M. Yaffe is head of Skadden’s West Coast Executive Compensation and Benefits Group. He counsels boards of directors, public and private companies, private equity firms and senior executives on a broad range of compensation and benefits matters. His practice includes advising on the tax and securities issues arising in equity includes advising on the tax and securities issues arising in equity compensation arrangements and handling the employee benefits issues in corporate transactions such as mergers and acquisitions, spin-offs and other business combinations.

Scrutiny of director compensation is likely to increase in 2019. Institutional Shareholder Services (ISS) has adopted a policy recommending votes against board and committee members responsible for setting or approving non- employee director pay where there is a recurring pattern of excessive director compensation without a compelling rationale for pay levels. ISS has indicated it will identify “outlier” companies that compensate board members excessively by comparing individual nonemployee director pay totals to the median of all nonemployee directors at companies in the same index or industry.

At the same time, plaintiffs have challenged director compensation in the Delaware courts on the basis that director compensation decisions are subject to a heightened, entire fairness, standard of review (instead of being protected under the business judgment rule). The rulings in those cases, including the Investors Bancorp decision issued by the Delaware Supreme Court in December 2017, appear likely to lead to increased shareholder litigation challenging director pay in 2019.

In the face of these issues, boards should consider revisiting their board compensation processes to consider and make adjustments as necessary based on director pay practices at peer companies, applying and seeking shareholder approval of director compensation limits and revisiting proxy disclosure of the director pay process and philosophy to ensure it is accurate, transparent and appropriately explains the rationale for director pay levels.

2019 is also likely to see an increase in legal and nonlegal challenges to compensation and employment decisions arising out of inappropriate workplace (or outside of the workplace) conduct involving sexual harassment, discrimination and abusive behavior. In light of the reputational harm to companies that can arise from such conduct, boards will be under pressure to review, understand and potentially adjust employee agreements and policies to ensure the board has significant flexibility in addressing such issues. For example, senior executive employment agreements that provide for substantial severance payments depending on whether an employment termination is for “Cause” should be reviewed to determine whether all conduct potentially injurious to the company constitutes “Cause” for termination. In addition, boards are likely to be questioned whether compensation clawback or recoupment policies appropriately address such circumstances and will potentially face pressure to revise them if not. These issues are going to arise in the context of ongoing discussions about board diversity, including pending legislation in several states that would mandate increased gender diversity on boards.

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Zach Oleksiuk is a Managing Director in Evercore’s corporate advisory business, specializing in shareholder engagement, corporate governance, ESG and investor relations. Mr. Oleksiuk is an active thought leader in the corporate governance community and is a frequent speaker to audiences of corporate directors and executives, investors, regulators, students and other market participants. Mr. Oleksiuk was previously Head of the Americas for BlackRock Investment Stewardship.

Risk management has become a centerpiece of board discussions at U.S. public companies. While every business faces a unique set of competitive and business challenges and attendant risks, there is a common theme in the area of addressing these risks—boards need to communicate their risk management framework to investors and also be sensitive to investor views regarding risks.

And what are the top risks in the minds of investors? A recent Evercore ISI survey of approximately 225 institutional investors showed that nearly 50% identified either Trade Policy or Policy Uncertainty as the most prominent risk for companies over the next 12 months. Beyond policy risks, investor respondents are worried about interest rates, geopolitical tensions (ex-trade policy), pro􀃖t growth, top line growth and general economic concerns. These views should provide a useful roadmap as boards assess risk and communicate with their shareholders.

Beyond the global risks that are on the radar screen of shareholders, what else should boards be worried about? Every year, companies face business challenges as their competitive landscape evolves, while they also need to set the right tone at the top to ensure the company’s culture is an asset and not a liability. Rigorous oversight by boards of business and cultural risks should be comprehensive and ongoing.

Moreover, this risk oversight process needs to be communicated to shareholders. Companies should ensure that investors understand:

• Company strategy and the long-term value proposition of the business

• The company’s assessment of emerging opportunities, key risks and plans foregone

• That the company has taken credible action to manage and mitigate

• Relevant risks, and has the right board to oversee risk management

• That the company is providing transparency with respect to risks, and is establishing the right lines of dialogue with shareholders