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12 February 2018
In 2016, the AFL-CIO submitted several shareholder proposals designed to curb the impact of stock buybacks on executive compensation. (See this PubCo post.) The question at the time was whether we would see many more of these proposals. However, amid significant media and academic criticism, as well as relatively high stock valuations, the levels of stock buybacks declined, and the anticipated wave of proposals on buybacks did not materialize. However, the new tax act is expected to trigger a new spike in the levels of stock buybacks. (See this MarketWatch article.) Perhaps with that in mind, one of the most prolific proponents of shareholder proposals has submitted a proposal to eliminate the impact of stock buybacks in determining executive compensation. Will these proposals now become a thing?
When hedge fund activists target a company, they often demand that the company engineer a return of capital to shareholders through, among other things, stock buybacks. Company executives are sometimes in sync with this type of demand because, in cases where compensation performance metrics are stock-price- or EPS-related, buybacks can juice executive compensation, irrespective of the operational success of the company. However, the concept of the stock buyback has attracted its fair share of media criticism, along with serious scrutiny from academics, claiming that buybacks and related short-term stock price hikes come at the expense of long-term value creation. (See this PubCo post and this PubCo post.)
In 2016, the AFL-CIO (and entities apparently acting on its behalf) attempted to curtail the impact of buybacks on executive compensation by submitting shareholder proposals to Illinois Tool Works, 3M and Xerox, asking these companies to adjust executive pay metrics to exclude the impact of stock buybacks. (See this PubCo post.) In each case, the proposal failed to achieve the required shareholder vote. (Note that, during the same proxy season, an unsuccessful attempt was made to exclude a very similar proposal by another proponent,) Interestingly, the AFL-CIO also indicated that it had submitted the same proposal to IBM at the same time, but the proposal did not appear in the proxy statement filed for IBM, nor was there a no-action submission to the SEC staff. However, in its 2016 proxy statement, IBM did enhance its description of its Performance Share Units to address the impact of "unplanned" stock buybacks for awards made in 2016 and beyond. While only the parties know for sure, one possibility is that this change reflected the results of a negotiated settlement with the AFL-CIO to withdraw the proposal.
Nevertheless, the change was apparently not enough to satisfy James McRitchie, who (with John Chevedden as proxy) submitted another proposal to IBM this proxy season on the same topic. More specifically, the proposal requested that the board "adopt a policy that it will not utilize earnings per share, or its variations, or financial ratios, in determining a senior executive's incentive compensation or eligibility for such compensation, unless the board utilizes the number of outstanding shares on the beginning date of the performance period and excludes the effect of stock buybacks that may have occurred between that date and the end of the performance period."
The company sought to exclude the proposal on the basis of Rule 14a-8(i)(10), substantial implementation, because the company's comp committee "already follows procedures and has adopted practices to eliminate the potential influence of share buyback programs on executive pay, and therefore has substantially implemented the proposal." As characterized by the company, the proponent's concern was that "using metrics like EPS that are subject to the influence of share buyback programs provides an incentive for senior executives to authorize share repurchase programs at the expense of reinvestment" of the funds in the company. However, the company maintained, its current practices "already accomplish the essential objective of the proposal." The company's policy, the company asserted, is to set performance targets for operating EPS, the only metric where share repurchases could have an impact, by taking into account "a budgeted amount of share repurchases in an applicable performance period. By accounting for a budgeted amount of share repurchases when setting performance targets, the impact of such budgeted repurchases on the performance result is neutralized." To offset any unplanned share repurchases, for the purpose of the performance metric, the company then makes adjustments to operating EPS, which, the company contended has "the effect of neutralizing and removing the impact of share repurchases from the calculation of operating EPS and its effect on executive compensation."
The proponent responded that his proposal was aimed at eliminating entirely the concept of budgeted share buybacks: "The proposal asks the Board to utilize the number of actual shares outstanding at the beginning of the performance period and to deduct the effect of share buybacks between that date and the end of the performance period. It clearly does not seek to include any 'budgeted amount of share repurchases to be made during the period.' Actual shares outstanding are not the same as actual shares PLUS the 'budgeted amount of share repurchases.'" According to the proponent, the company had "not adopted practices that eliminate the potential influence of share buybacks on executive pay. Instead, they have budgeted for those influences. Avoiding an impact is not the same as budgeting for or anticipating an impact. The requirements of Rule 14a-8(i)(10) have not been met."
In issuing its no-action response allowing exclusion of the proposal, Corp Fin agreed that it appeared that the company's "policies, practices and procedures compare favorably with the guidelines of the Proposal and that the Company has, therefore, substantially implemented the Proposal."
The question at the time of the AFL-CIO submissions was whether we would see many more of these proposals. Now that the proposal has become part of the repertoire of the prolific Chevedden group— who are typically undaunted by just a single Corp Fin decision to allow exclusion—it would not be surprising to see this type of proposal resurface more frequently, especially if, in light of the recent tax law change, the level of stock repurchases resumes a sustained upward climb.
For further information on this topic please contact Cydney Posner at Cooley LLP by telephone (+1 415 693 2000) or email (email@example.com). The Cooley LLP website can be accessed at www.cooley.com.
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