Executives typically receive the smallest portion of their annual compensation in the form of a base salary. Incentive pay accounts for the bulk of executive pay and companies provide it through annual cash bonus plans and longer-term equity awards. Boards typically structure incentive pay to focus executives on particular goals, such as growing earnings per share (EPS). However, boards often calculate a goal such as EPS using a custom formula that bears little resemblance to the calculation under Generally Accepted Accounting Principles (GAAP). Companies refer to the custom formula in corporate filings as an adjusted GAAP metric. The IOA, and now the IOPA, includes this topic as part of the opioid effort because many opioid supply chain companies excluded legal and compliance costs in their adjusted GAAP metrics for executive incentive pay. Boards were therefore insulating executives from the financial penalty of opioid litigation at a time when investors bore the impact in their earnings, which have no such luxury of being adjusted.
IOPA members including the City of Philadelphia Public Employees Retirement System and the Vermont Pension Investment Committee in consultation with Segal Marco Advisors have submitted proposals to opioid supply chain companies asking that they itemize adjustments and explain them in the compensation discussion and analysis section of the proxy statement. Ahead of the 2021 shareholder season, the IOPA wrote letters to the opioid supply chain companies to inform them that investors would evaluate their decision to adjust GAAP metrics and the transparency of the reporting.
The Council of Institutional Investors (CII) filed a petition to the SEC for rulemaking on companies using non-GAAP metrics when calculating executive pay. CII points to research by Robert Pozen at MIT that showed, “in 2016, adjusted earnings of 28 companies in the S&P 500 showed substantial profits, even though their GAAP earnings were actually losses. Another 37 companies reported adjusted earnings that were more than 100% higher than their GAAP earnings. Of these 65 companies, 62 used adjusted earnings as compensation criteria in their CD&As.” CII’s petition asks the SEC to require that companies clearly explain their use of non-GAAP metrics and show how to reconcile these with the appropriate GAAP metrics.
IOPA members saw success working with companies that agreed to implement transparency on adjusted metrics within the proxy statement. Enhanced disclosure enables investors to assess whether they find the executive pay plans merit support. In 2021, the IOPA encouraged investors to vote down executive pay plans at a limited number of firms that booked significant opioid-related litigation charges and excluded the impact of those charges when calculating metrics that determined executive incentive pay. The result of such decisions means while shareholders see the impact of opioid-related litigation charges in their investment returns, executive pay is unaffected.