A Look at Tech Exec Compensation During Shareholder Season

In the 2007 proxy season, public companies complied with the new Securities and Exchange Commission requirements regarding executive compensation disclosure, which provided more data about salary, bonuses, stock options, perks and long-term incentive compensation plans.

Today, CFOs at U.S. technology businesses are finding that some of the other legislative and regulatory changes regarding executive compensation, such as 409A and FAS 123R, are impacting their companies’ compensation plans. Shareholders are also increasingly seeking more say in approving changes to executive compensation. In order to address these concerns for the 2008 proxy season, executive management, boards of directors and shareholders of U.S. technology companies must first explore all facets and issues surrounding executive compensation.

The Statistics

Only 31 percent of chief financial officers at leading U.S. technology businesses indicate that their company allows shareholders to vote on their executive compensation plans, compared with more than two-thirds (69 percent) that do not, according to BDO Seidman data. Yet a majority (61 percent) of the CFOs personally feel shareholders should have a say on executive compensation plans, compared with over one-third (39 percent) who do not.

Moreover, two-thirds (67 percent) of CFOs at technology businesses indicate that their companies’ compensation plans have been impacted by legislative and regulatory changes, such as 409A and FAS 123R, focused on improved disclosure. Of those impacted, more than one-quarter (27 percent) described the impact as high, 37 percent described the impact as moderate and 36 percent said low.

These findings are from the BDO Seidman 2008 Technology Outlook Survey, which examined the opinions of 100 chief financial officers at leading technology companies located throughout the U.S., including a subset in Silicon Valley. The technology businesses in the study have revenues ranging from more than US$100 million to $15 billion.

A Say on Pay

Due to last year’s SEC disclosure rules on executive pay, shareholders now have greater knowledge of executive compensation packages at U.S. technology companies. While shareholders rarely vote on the amounts allocated to specific executives from an aggregate compensation pool, they do generally get to approve the parameters of the programs when equity-based compensation plans and annual bonus plans are submitted for their approval.

In the interim of being granted further involvement in determining executive compensation for their respective companies, shareholders (alongside executive management and board of directors) should focus this year on the legislative and regulatory changes affecting executive compensation.

Section 409A

Section 409A of the Internal Revenue Code, which came into law in 2004, requires most employment agreements, nonqualified pension arrangements, change in control agreements, bonus plans and some equity compensation plans to be amended to limit the flexibility the executives previously had when deferring compensation to minimize their current tax liability.

For example, if a technology company violates this new law, whether or not the violation was intentional, the income is declared “accelerated” and is subject to an additional 20 percent tax (40 percent for companies based in California) plus interest.

Private companies have to be mindful of Section 409A when granting stock options because it exempts stock options from the onerous tax consequences only if the grant price on the date of grant is no less than the market value of the stock on that same day. The IRS basically requires private companies to get an independent appraisal to be safe, although there are a few exceptions to that requirement.

FAS 123R

Financial Accounting Standards (FAS) 123R, which changed the accounting expense rules in 2006 for equity-based compensation such as stock options and restricted stock, allows for shareholder-friendly changes to executive compensation. Under the former accounting rules, companies were reluctant to add financial performance requirements to equity grants because of potential uncontrolled compensation book expense as the value of the company’s stock rose.

Now, under FAS 123R, companies can add financial performance goals to an equity grant in addition to service-based vesting, without getting hit with an uncontrolled compensation expense because the expense is charged at the time of grant.

For example, in lieu of making a grant of restricted stock that executives would benefit from if they are simply employed at the end of three years, the company could also require that a performance target, such as earnings per share growth, be achieved during that time, or the award will be forfeited. The expense of this grant is determined at the time of grant to the executive and then recognized by the company over the vesting period. A number of companies both public and privately held have moved in this direction to further align executives with the longer-term goals of the company and with shareholder interests. This can be considered a win-win approach for the executives and shareholders.

FAS 123R does add some significant administrative burden as it relates to stock options. The rules require a valuation (most use the Black-Scholes-Merton valuation model) to be completed for every stock option grant to determine the book expense. Because the tax accounting related to that expense can be complicated, a small percentage of companies are moving away from stock options and into granting restricted stock.

Proxy Disclosure Rules

With respect to the new proxy disclosure rules established by the SEC effective for proxies filed in 2007, it is not certain that these rules have had much impact on executive compensation plans for technology companies. Certainly, the new columnar total compensation table and supporting tables provide the shareholders and the public with a more uniform approach to making executive compensation comparisons among peer companies. What is not yet clear is the impact, if any, that this new form of disclosure will have on executive compensation arrangements.

Since base salary, annual bonus and equity compensation grants have been readily available for many years, then there should not be much change to these executive compensation components. However, one area of executive compensation that may be impacted at technology companies is the amount of severance and other payments in the event of a change in control at the company. This information has not been reported in the past, at least in terms of a dollar amount that shareholders and the public can identify with.

Regarding change in control and golden parachute payments under Tax Code Section 280G, these amounts are likely to vary greatly among technology companies. Thus, compensation committees will take a closer look at executives’ employment and change in control agreements from a competitive and business strategy perspective.

In the past two years, there have been significant changes in executive compensation plans that are pro-shareholder oriented, primarily adding performance criteria to equity-based compensation. Whether technology companies turn to shareholders to provide input or approval over all aspects of executive compensation remains to be seen. If technology companies do solicit shareholder approval or input on all facets of their executive compensation programs, then this practice is expected to be adopted gradually over time.