Whether we are shareholders, customers or employees of a business, we must always ask if a CEO has enough skin in the game.
I am not a regular reader of a US publication called Compliance Week, but I was recently forwarded an interesting article from this trade publication.
US corporations typically ask their CEOs to retain five times their base pay in company stock, give them five years to get there, disclose the practice on their proxy statement, and forget about it. However, the journal says a push may be coming to re-examine the effectiveness of such plans and consider increasing the equity CEOs are required to hold.
In the UK, stock ownership guidelines and holding periods are hot issues, with shareholders asking CEOs, other senior executives and board members to hold more equity, for longer periods.
When the regulations came in back in 2018, 65 of the companies in the FTSE-350 increased the shareholding requirement for CEOs, 62 increased the amount other senior executives must hold, and 49 made executives hold their shares for longer after exercising stock options or receiving share awards.
“Share ownership guidelines are one of the top ways to align the interests of top executives and shareholders,” says Cimi Silverberg from US executive compensation adviser FW Cook. “The idea is to make them think and act like owners by making them owners.”
Some UK firms are reacting to pressure to increase that alignment. Drug manufacturer GSK proposed that its CEO, Dame Emma Walmsley, be required to increase her equity in the company up to 6.5 times her base salary. And while it left the requirement for the rest of the C-suite to three times base pay, it took the extra step of expecting those ownership levels for 12 months into retirement.
Other British companies that increased the level of share ownership requirements include Acacia Mining and Aggreko, which doubled the portion of stock they require their CEOs to hold.
Some investors are already calling for better share ownership policies. Larry Fink, CEO of BlackRock (which has $5.7-trillion in assets under management and has been known to side with activist investors) has called for companies to find better ways to incentivise executives to think as long-term investors.
A few years ago, a group of heavyweight investors and CEOs — including Fink, Warren Buffett and their counterparts at fund management giants Vanguard and T Rowe Price and several others — released an open letter calling for the adoption of a set of “common-sense corporate governance practices”.
Data going back to 2013 shows that most Russell 3000 companies, and nearly all of the S&P 500, have implemented equity ownership guidelines for their CEOs. Among large-cap companies, share ownership guidelines have been the norm for some time, and the outliers who don’t have them are often planning to introduce them.
Compliance Week says among smaller companies the adoption rate isn’t as high, but it is steadily increasing year by year. While many public companies are requiring their top executives to own anywhere from five to six times’ their annual base salary in company shares, some companies require even more skin in the game, at 10 times base salary. These include Apple, General Mills, Lowe’s, Microsoft, Morgan Stanley and Wells Fargo.
However, executive compensation experts say the topic of share ownership guidelines has not been an active governance issue in the US in recent years. “There hasn’t been a ton of movement in terms of design of these plans,” says Matthew Goforth, senior governance adviser at Equilar, an executive compensation and board governance advisory firm.
“The old gold standard was five times, but we have seen it migrate to six times during the past few years,” says John Roe, MD and head of analytics at Institutional Shareholder Services. Whether holding periods should be increased is a hot topic, as is how long CEOs, other executives and directors are required to hold shares after their options vest.
Some companies, such as Eli Lilly, require the CEO and other top executives to hold all shares from equity payout programmes for at least one year. While such requirements are less common than those that require holding a certain percentage (generally 50%), Roe says they are a good way to align management and shareholder goals. “Post-vesting holding requirements are a good way to create alignment and have more teeth than plans that require holding only until ownership guidelines are met,” says Roe.
Some governance experts warn that increasing share ownership guidelines too high can have unintended consequences. “If CEOs have too much of their personal wealth at stake they might have an incentive to either take too much or too little risk, depending on the situation,” says Equilar’s Goforth.
He points to another problem with setting stock ownership requirements too high — it could become a hindrance to hiring and retaining top executives. “Competition for top executives is intense and no-one wants to be an outlier on ownership guidelines.”
Compliance Week argues that unless pressure intensifies, most companies will take a Goldilocks approach to stock ownership guidelines: not too high and not too low, generally going with six times for CEOs, four times for the CFO, and three times for directors and other top executives. “Most people agree it’s a good corporate governance standard,” says Goforth.
• Cranston is a former associate editor of the Financial Mail.
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