As I skim through various proxy statements each week, I rarely spend much time reading the compensation-related risk disclosures that are included in or follow the Compensation Discussion and Analysis. An outgrowth of the SEC’s addition of Item 402(s) to Regulation S-K following the financial crisis of 2008-2009, the disclosure, which is typically “negative” in nature (that is, a statement saying that there is nothing that is required to be disclosed), tends to be of varying length, content and scope. Sometimes, it’s limited to discussing risk as it relates to the executive compensation program (which is really all that’s contemplated by the CD&A) and other times it encompasses the company’s enterprise-wide compensation programs (the real focus of Item 402(u)). It’s probably fair to say that these disclosures seek to accomplish two primary goals — to make clear that management and the Board Compensation Committee are monitoring compensation-related risk on an ongoing basis and to confirm that such risks are not reasonably likely to have a material adverse effect on the company.
Every so often, I come across an interesting example of a risk disclosure, the most recent of which I encountered in the definitive proxy statement of Honeywell International, Inc. Not only does it reach the conclusion of other risk assessments — that the risks arising from the company’s compensation policies and practices are not reasonably likely to have a material adverse effect on its operations or results, it also sets out a pretty thorough explanation of how its compensation program design and policies contribute to this result. Here’s what the company has to say about its compensation risk oversight:
The MDCC [Management Development and Compensation Committee] believes that balancing the various elements of Honeywell’s executive compensation program:
Supports the achievement of competitive sales, earnings, and cash performance in variable economic and industry conditions without undue risk; and
Mitigates the potential to reward risk-taking that may produce short-term results that appear in isolation to be favorable, but that may undermine the successful execution of the Company’s long-term business strategy and destroy shareowner value.
The following compensation design features guard against unnecessary or excessive risk-taking:
RISK OVERSIGHT AND COMPENSATION DESIGN FEATURES
Robust processes for developing strategic and annual operating plans, approval of capital investments, and internal controls over financial reporting and other financial, operational, and compliance policies and practices.
Diversity of the Company’s overall portfolio of businesses with respect to industries and markets served (types, long-cycle / short-cycle), products and services sold, and geographic footprint.
MDCC review and approval of corporate, business, and individual executive officer objectives to ensure that these goals are aligned with the Company’s annual operating and strategic plans, achieve the proper risk/reward balance, and do not encourage unnecessary or excessive risk-taking.
Executive Compensation features that guard against unnecessary or excessive risk-taking include:
Pay mix between fixed and variable, annual and long-term, and cash and equity compensation is designed to encourage strategies and actions that are in the Company’s long-term best interests;
Base salaries are positioned to be consistent with executives’ responsibilities so they are not motivated to take excessive risks to achieve financial security;
Incentive awards are determined based on a review of a variety of performance indicators, thus diversifying the risk associated with any single performance indicator;
Design of long-term compensation program rewards executives for driving sustainable, profitable, growth for shareowners;
Vesting periods for equity compensation awards encourage executives to focus on sustained stock price appreciation; and
Incentive plans are not overly leveraged with maximum payout caps and have design features that are intended to balance pay for performance with an appropriate level of risk-taking. The MDCC also has some discretionary authority (e.g., 20% of awards) to adjust the annual ICP payments, which further reduces the potential for negative business risk associated with such plans.
Adoption of clawback policies, which provide for the recoupment of incentive compensation paid to senior executives if there is a significant restatement of Company financial results. Clawback provisions in the Company’s current stock plan also allow the Company to cancel shares or recover gains realized by an executive if non-competition or non-solicitation provisions are violated.
Prohibition on hedging and pledging of shares by our executive officers and directors.
Ownership thresholds in the Company’s stock ownership guidelines for officers that require NEOs to hold shares of common stock equal to four times their current annual base salary (six times for the CEO), as detailed in the Stock Ownership Guidelines.
Officers must also hold 100% of the net shares from vesting of RSUs, the net shares issued from PSUs, and the net gain shares from option exercises for at least one year.
Based upon the MDCC’s risk oversight and compensation policies, the risks arising from our compensation policies and practices are not reasonably likely to have a material adverse effect on Honeywell’s operations or results. A full discussion of the role of the Board in the risk oversight process begins on page 23 of this Proxy Statement.
I’m a fan of this type of robust disclosure which, at a minimum, helps focus the company on the details of its compensation-related risk profile, as well as several of the higher level areas that influence the identification, management and mitigation of risk. To me, the disclosure offers some useful insights into the type of items that should be considered when assessing the risk of an executive compensation program, particularly as compensation programs become more sophisticated and complex.
-Mark Borges, CompensationStandards.com March 13, 2020
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