New rules regarding disclosure of hedging and pledging could result in controversy
Dear readers,
A lot of attention has been focused on executive compensation of late. The Dodd-Frank legislation has expanded the type of information that has to be disclosed and as a result compensation is probably going to be the hottest topic of next year’s spring proxy season.
No doubt you are all becoming intimately familiar with some of the new provisions: say-on-pay, CEO pay disparity, clawback provisions and the like. One area that has not been getting a lot of media attention, probably because it is not particularly sexy and more than a little complicated, is the practice of pledging or hedging shares.
The financial reform legislation demands increased disclosure of these transactions, which have historically been hidden in obscure filings and reports or as difficult to find footnotes on the annual proxy statement.
Since a lot of people seem to have ignored this part of the rules, and even more probably don't really understand exactly what hedging and pledging really is, we figured it would be a good idea to conduct a survey to find out how many companies allow executives to hedge and what sort of restrictions they place on it. You can read about the results here
I know what you are thinking: what the hell is hedging and why should I care? The reason you should care is that the act of hedging and pledging shares can undermine the issuance of stock and options and their link to performance. And when shareholders figure this out – which they are likely to do since it is going to be disclosed as of next year – there is going to be trouble. Shareholders are excited enough about compensation and performance, you don't want to give them any more reason to get upset.
So what is pledging and hedging? Pledged shares are used as collateral for a loan and hedging involves taking out an opposite future contract to offset downside risk (and also realize the current real-time value of the shares).
With variations like prepaid variable forwards, zero-cost collars, exchange traded funds and equity swaps, it is no wonder people find it confusing. Basically what all this means is that, while your executives might be accumulating equity in the company and might appear to have significant ties to long-term share prices, it might not actually be true at all. According to one report executives at US companies trade out 30 percent of their equity. This has a serious impact on the supposed linkage to performance that shares are meant to provide.
In our survey, which was conducted jointly with Stanford Law School, we find that most large US companies do not allow any form of hedging or pledging. A full 25 percent do permit it and even more allow the use of 10B5-1 plans. These plans are also set to come under greater scrutiny because of apparent links to insider trading.
I won’t go into all the details here but you should check out the results of the survey. There are also some examples of hedging and pledging policies from a few companies that you can look into. I know how you all love practical examples and since every company needs to include disclosure regarding their policy as of next year I suggest you start thinking about it.
And while you are looking at compensation, there is a new report from BDO that examines compensation for board directors. Despite the dramatic increase in responsibility, growing frequency of meetings and shifting liability, it appears that director pay increased a measly 2 percent in the past year. Maybe this is part of the reason so many companies are finding it harder to recruit directors. Why would anyone want to work harder, take on more risk and not get paid any extra for it? I know I wouldn’t. Although, given that average director compensation remains at very healthy levels perhaps I could be tempted.
