Corporate Directors Want to Rein In “Overboarding” and Improvements to Non-GAAP Metrics

Overboarding

In recent years, directors have seen a major increase in the number of hours required to serve on a public company board.  Given this trend, in 2017, proxy advisory firms ISS and Glass Lewis have indicated they will oppose non-executive directors with more than 5 board seats. Interestingly, board members themselves are in favor of more severe limits.

When asked about the issue of “overboarding”, approximately three-quarters (74%) of directors believe corporate boards should proactively limit the number of boards on which a director can serve.  Of those in favor of setting limitations, more than three-quarters (79%) would set more severe limits than the proxy advisors.  Forty-four percent would set the limit at three boards, more than a quarter (28%) chose four, and less than 10 percent said two (6%) or one (1%).  Only nineteen percent of directors agreed with the proxy advisors suggested limit of 5 board seats.

Financial Reporting Disclosures

Seventy percent of board members believe that there are so many disclosures in financial statements today, that it is difficult to decide what information is most important.  When asked to identify the most meaningful financial reporting disclosures for investors, approximately half (49%) cited critical audit matters that involve complex judgements on material issues.  Non-GAAP financial measures that provide supplemental information on a business’s performance (29%) and how the organization is addressing risk management (19%) were the next most cited as meaningful disclosures. 

More than two-thirds (71%) of public company board members believe disclosures regarding the audit committee’s oversight of the external auditor provide value to current and potential shareholders.  Alternatively, less than a quarter (24%) of directors believe disclosures regarding sustainability matters (climate change, corporate social responsibility, etc.) are important to investors’ understanding of a company’s business and enabling them make informed decisions.

Non-GAAP Metrics
Board members were split when asked whether they thought additional guidance from regulators on non-GAAP metrics would be helpful, given the increased use of these measures in financial statements.  About half (51%) were in favor of additional guidance, while a similar proportion (49%) saw no need for more regulatory guidance.  Of those in favor of additional guidance on non-GAAP measures, close to half (46%) identified EBITDA as the metric that causes them the most concern.  Restructuring costs (14%), stock-based compensation (13%) and acquisition integration costs (13%) were areas of concern cited by much smaller minorities of directors.

Two-thirds (67%) of the board members feel auditor involvement would provide higher investor confidence in the reporting of non-GAAP measures, compared to a third (33%) who do not feel it will have an impact.
Despite the popular criticism that non-GAAP or pro forma figures – when used with compensation metrics –  can help executives draw bigger pay packages, approximately three-quarters (74%) of directors are opposed to prohibiting the use of non-GAAP measures in executive compensation calculations.

Executive Compensation

Frequency of Say-on-Pay.  In 2011, the Dodd-Frank Act instituted mandatory “Say-on-Pay” shareholder votes on executive compensation which should be conducted every one, two or three years, as determined by the shareholders.  The frequency of these shareholder votes is to be revisited and voted on every six years.  In 2017, most public companies will be conducting a new shareholder vote to determine the frequency of Say-on-Pay votes moving forward.  This year’s survey reveals that directors see a disconnect between themselves and shareholders on this issue.

Based on their experience over the past six years, a majority (56%) of board members believe the votes should take place every three years, compared to approximately a fifth (19%) preferring two years and a quarter (25%) opting for every year.  However, when asked to predict how their shareholders will vote on the frequency of Say-on-Pay votes, half (51%) the directors predicted every year.  The remainder were split between every two (22%) and every three (27%) years.

Communicating on Pay.  Forty-one percent of directors do not consider it appropriate to communicate with institutional shareholders regarding incentive pay packages.  In contrast, at least one-fifth (22%) of directors say their board or compensation committee does proactively communicate with institutional shareholders on the topic and slightly fewer (18%) indicate they are considering such communications.  Interestingly, of the relatively few actively communicating, two-thirds (66%) believe it has positively impacted their investor relations.  Only three percent believe it hasn’t.  The remainder (31%) weren’t sure.

CEO – Median Employee Pay Ratio.  Beginning with 2018 proxies, public companies will be required to disclose the ratio of median employee pay to CEO compensation.  This 2018 requirement will report on 2017 compensation.  When asked if their boards had begun to take steps to comply with this new requirement, directors were split.  Almost half (49%) are familiar with the new requirement but have taken no actions, while better than one-third (37%) are already preparing pay ratio calculations for internal planning purposes – though they will not disclose the ratio prior to the required disclosure date.  Relatively few (8%) say they are planning to disclose the pay ratio calculation prior to the mandatory disclosure date. Surprisingly, 6 percent of the directors say they are still unfamiliar with the requirement.

Director Pay Limits?  Recent shareholder lawsuits alleging excessive director pay have put a spotlight on how boards determine their own pay.  When asked about the topic, a majority (56%) of board members were opposed to director pay limits, compared to forty-four percent in favor of limits.   Of those in favor of limits on director pay, a strong majority (81%) favor total compensation limits versus the remainder (19%) that prefer only equity limits.

Presidential Preference?
When asked which of the two major party presidential candidates would positively impact corporate governance, Donald Trump (25%) received twice the support of Hillary Clinton (12%), but the most popular opinion (54%) of the board members was that neither candidate will have a positive impact.

BDO Board Survey
These are just a few of the findings of the 2016 BDO Board Survey, conducted by the Corporate Governance Practice of BDO USA in September 2016.  The annual survey examines the opinions of 160 corporate directors of public company boards regarding financial reporting, executive compensation, risk management and other corporate governance issues. 

BDO USA’s Corporate Governance Practice is a valued business advisor to corporate boards.  The firm works with a wide variety of clients, ranging from entrepreneurial businesses to multinational Fortune 500 corporations, on myriad of accounting, tax, risk management and forensic investigation issues.