Opinions February 24, 2021

Considering Say-on-Pay Proposals for NQDC Plan Designs

It’s worth examining how shareholders might view the compensation executives receive through NQDC plan designs.
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Art by Julianna Brion

As many experts on retirement policy know, due to government mandated limits, a relatively small portion of an executive’s earnings can be saved under tax-qualified defined contribution (DC) programs. Therefore, in order to attract the best executive talent in the market, many companies maintain nonqualified deferred compensation (NQDC) plans to provide for additional retirement contributions beyond the IRS-mandated limits.

Institutional Shareholder Services Inc. (ISS), the parent company of ISS Media, provides proxy voting recommendations to investors on millions of annual shareholder meeting ballot items each year. These vote recommendations cover a broad range of management-driven and shareholder-initiated proposals including director elections, equity plan share requests and the separation of CEO and board chair roles, among others.

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One common ballot item is known as a “say-on-pay” proposal, which is a non-binding vote that a company submits to its shareholders affording them an opportunity to support or oppose the company’s executive compensation decisions over the past year. ISS evaluates more than 2,000 say-on-pay proposals in the U.S. each year, and its evaluation includes a detailed review of executive compensation practices and incentive design considerations, including supplemental executive retirement plans (SERPs) and NQDC plans. At a high level, ISS does not conduct an in-depth review of the structure and design features of these plans (e.g., total value of restoration benefit, matching contributions, etc.) but there are a few practices it scrutinizes to gauge whether they are aligned with shareholders’ interests. Specifically:

  1. Does the company’s pension formula include additional years of service not actually worked or long-term incentive pay in the pension formula, resulting in higher pension values?
  2. Does the company provide above-market interest, excessive matching contributions or guaranteed minimum returns on deferred compensation arrangements?

ISS considers the first practice outlined above a highly problematic pay practice, and it will likely lead to a negative vote recommendation from ISS on a say-on-pay proposal on its own, regardless of any appropriate alignment between executive pay and company performance.

The use of above-market interest, excessive matching contributions or guaranteed minimum returns under NQDC plans isn’t viewed as critically by ISS. However, the use of these items is not viewed as shareholder-friendly by ISS, as the benefit is not performance-based and is generally not available to broader employee populations. The inclusion of such arrangements will be noted in ISS’s evaluation of a say-on-pay proposal and could lead to a negative vote recommendation by ISS, particularly if the interest payments represented a significant portion of the CEO’s total compensation for the year under review.

Company Case Studies

ISS supported Freeport-McMoRan Inc.’s 2020 say-on-pay proposal but cited minor concern with the above-market interest payments of $362,373 provided to the CEO. Comcast Corp. provided above-market interest payments of approximately $7.6 million to its CEO in fiscal year 2019, which led ISS to issue an “against” vote recommendation for its say-on-pay proposal in 2020.

One particular interesting case has been a shareholder proposal that has been submitted to Verizon Communications Inc.’s board of directors for the past three years. A group of shareholders has asked Verizon’s board to adopt a policy that prohibits the practice of paying above-market earnings on the non-tax-qualified retirement saving or deferred income account balances of Verizon senior executive officers. The supporting statement issued by the proponents of eliminating above-market earnings in compensation indicated that Verizon offers its senior executives far more lucrative retirement savings benefits than rank-and-file employees receive under the broad-based tax-qualified savings plans, which provide matching contributions of 6% of an employee’s base salary. (Verizon’s board recommended shareholders voted against the proposal, citing the fact that above-market returns were not provided to executives in 2019.)

ISS has supported the shareholder proposal by issuing a “for” vote recommendation in all three years it has been on the ballot, and, in that recommendation, ISS indicated that

investors have increased their scrutiny of supplemental benefits to executives that do not require a link to performance.


The proposal has failed to achieve majority support each year it has been on the ballot, but the level of shareholder support that it has achieved is in line with the average support for shareholder-initiated proposals in the broader market, as shown in the accompanying chart.

Russell 3000 Investor Support for Shareholder-Initiated Proposals 2018–2020

Eliminate Above-Market Earnings (VZ)
All R3K Shareholder Proposals
2018
28%
33.1%
2019
27%
32.5%
2020
31.1%
32.5%
Source: ISS Voting Analytics Database

These data suggest that Verizon’s use of above-market returns for executives under its deferral plan is supported by a substantial majority (roughly 70%) of its shareholder base, as support for eliminating the practice has hovered around 30% in each of the past three years. However, the continued presence of this proposal at Verizon’s annual meeting may increase pressure on the board to reconsider the issue, as more investors recognize that the use of above-market earnings in NQDC plans is not considered performance-based compensation and is an uncommon practice in the broader market.

Although these case studies are related to public companies, the discussions about plan design are valuable for any company constructing an NQDC plan. Private companies can also examine whether excessive matching contributions or some other guaranteed returns applied to executives’ deferred compensation arrangements are critical for retaining key executive talent and whether the practices are aligned with shareholders’ interests.

Brian Johnson is a member of the advisory team at ISS Corporate Solutions.

Investing February 23, 2021

Benchmarking Custom TDFs Is Not an Exact Science

However, there are methods to create a benchmark, and consultants and investment managers should be able to help.
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Benchmarking custom target-date funds (TDFs) is complicated and not an exact science, retirement plan experts say. They add that the additional administrative cost of conducting this type of benchmark has convinced many large plans to select off-the-shelf products rather than create custom ones.

Sue Walton, senior retirement strategist at Capital Group, says that prior to joining the investment firm, she was a consultant to mega plans, many of which asked her to explore custom versus off-the-shelf TDFs.

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“With custom solutions, it is quite challenging to find appropriate benchmarks, as opposed to a fund that is singularly focused on large-cap, growth or value,” Walton says. “However, there are index benchmarks available in the marketplace, such as the S&P 500 for large-cap, the Russell 2000 for small-cap and the MSCI ACWI ex-USA Index for emerging markets.”

If the plan positions the percentage of the benchmark of these indexes relative to the glide path of the underlying funds, it can create a multi-benchmark for a custom TDF, Walton explains. “It is not a perfect solution in that it cannot show you how the fund is performing relative to peers of off-the-shelf solutions, but it is an approximation that you can create. The benchmark would have to be recalibrated for each year of the vintage as the glide path changes. In that sense, it would be a dynamic benchmark. The adviser and the sponsor would have to rely on the asset managers of those strategies to provide this custom benchmark.”

It is precisely because of this complicated benchmarking process, Walton says, that “we have seen a number of large plan sponsors with custom strategies move away from those to off-the-shelf solutions.

“Even if the TDF selects best-in-class funds for each of the objectives of its glide path, funds don’t always play well together and complement each other,” she continues. “Further, sponsors and participants may not necessarily realize the benefits of the additional costs, particularly the administrative cost and the cost of education, of the custom solution. This sets a high bar for the custom solution to be able to add value, net of all of the administrative costs. This is not to say that custom solutions don’t work—it is just important for sponsors and advisers to be aware of their complexities.”

Jake Gilliam, head of multi-asset solutions at Charles Schwab, says that when plan sponsors are determining the benchmark for a custom TDF, it is important to understand “the unique problem that the sponsor is trying to solve by turning to a custom solution.

“That is the first and foremost point that should be addressed when determining how to benchmark the custom TDF,” he says. “The sponsor needs to ask itself how the fund and all the related education meet that need, and whether participants are using the strategy as intended. They can then explore how the fund is performing relative to other solutions that are off the shelf and ask the all-important question: ‘Is the custom solution adding value?’”

Gilliam also says he’s seen many large sponsors move away from custom solutions. “In general, the focus of the past several years has been on cost and complexity, and keeping cost as low as possible in step with limited complexity, which is why we have seen more interest among large plan sponsors in off-the-shelf solutions.”

However, David O’Meara, a senior investment consultant who specializes in TDFs at Willis Towers Watson, maintains that any expert retirement plan consultant or large investment manager should have a reporting system capable of matching multiple benchmarks against the glide path of a custom or an off-the-shelf TDF. “With the right tools and reporting system—one that houses all of the returns of all of the available indexes—it is fairly straightforward to put together. All you need to do is simply match up the target-date allocations with those indexes and roll them up at an aggregate level. For all the major consulting firms and investment managers, reporting this benchmark back to their clients should be a relatively straightforward process.”

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