Paul Hodgson: How ExxonMobil’s executive pay policy stands up to scrutiny

I’m not a fan of big oil, and I’m normally on the side of proxy advisory firms when it comes to criticising US executive remuneration policies, so to find myself supporting Exxon Mobil against ISS is something of an unusual position.
Not that ExxonMobil doesn’t have room for improvement, as I discuss below.
Exxon’s record on its advisory vote on remuneration, its Say on Pay vote, has not been good, though it is improving. In 2011, the vote was only 66% ‘for’; last year it was 76% ‘for’. This has been driven by negative recommendations from proxy advisory firm ISS. Exxon Mobil’s ISS Governance QuickScore as of May 1 2013 was 6, hit by a low executive pay rating of 8 (QuickScore runs from 1-10, with the higher figure being the worst score).
And ISS’s issues with Exxon? Its analysis of the company’s one and three-year total stockholder return (TSR) performance against an industry peer group contends that pay is out of alignment with performance. It finds that the annual performance bonus is discretionary and that restricted stock awards should be tied to performance metrics.
David Rosenthal, Exxon’s VP of Investor Relations has written to shareholders to counter most of ISS’s criticisms. Specifically, about the restricted stock/performance-restricted stock issue, he says: “We believe tying an executive’s net worth to long-term share performance creates the ultimate pay-for-performance.”
Last year, similar exhortations to vote against the same Say on Pay resolution at the 2012 AGM caused Exxon to issue not only a written special proxy, but even to run a webcast to defend its compensation policies.

Now, I am already on record – indeed I frequently use it as a shining example – for congratulating Exxon on the lengthy restriction and retention periods attached to its restricted stock grants. Restriction periods of five years, 10 years, and through and into retirement are far more draconian than are found almost anywhere else, and the company is rightly proud of them. As far as that is concerned, I agree with Rosenthal.But alleging that the only reasonable line-of-sight metrics possible are limited to three years is somewhat naive. If the company’s business model is “uniquely long-term”, then the line-of-sight is long-term and could easily be used to tie restricted stock to performance. Indeed, using a five to 10 year return on capital employed (ROCE) metric against the company’s closest industry peers would seem an obvious choice, especially since the company has explicitly indicated that it feels ROCE is a much better measure of performance than ISS’s beloved TSR.
I also agree with Rosenthal that there is evidence in the remuneration report in the proxy statement that would indicate that annual bonuses are far from discretionary, though I don’t agree that the earnings per share (EPS) trigger – the gateway through which performance must pass in order for bonuses to be paid – is the right argument to use against ISS’s judgment.
The right argument is found in just two bullet points in the proxy:
“An executive’s performance must be high in all key performance areas for the executive to receive an overall superior evaluation. Outstanding performance in one area will not cancel out poor performance in another.” It cites problems in “safety, security, health, or environmental performance” or violations of the company’s code of conduct.
I have long been looking for a company that uses sustainability measures to control its bonus payouts, and on reading these points, I felt I had found one. Reading between the lines, it seemed Exxon was a good example of a “silver standard” of metrics. If that makes the bonus plan discretionary, that’s a good thing.
But the bullet points could hardly be said to tell the whole story, so I arranged an interview with executives from Exxon’s Executive Compensation Group and its Investor Relations Group. After an hour of questions and answers I had begun to understand what was involved. It’s amazing how much information lies behind a couple of sentences in a remuneration committee report!
The first clue to figuring out what this actually might mean was found in the award certificate for the restricted stock awards, which noted that forfeiture would be required under a number of different circumstances, including:

Detrimental activity: “If Grantee is determined to have engaged in detrimental activity within the meaning of the Program, either before or after termination, all shares for which the applicable restricted periods have not expired will be automatically forfeited and reacquired by the Corporation as of the date of such determination.”
Of course, the lack of definition for “within the meaning of the program” then requires you to follow the filings trail further. This was to be found in the company’s stock plan descriptions, though reading them, I found it a little vague and I wanted to know what this meant and to whom it applied.
From the interview it became apparent that this sustainability risk management process is practiced in two ways: training and performance management; and enforcement. It applies to all employees, not just executives, as every employee must sign statements annually that indicate their compliance with the “applicable standards, policies, or procedures.” There are also business practice reviews every two years, with training seminars featuring “vignettes of real life examples of unethical behaviours”.
In addition, there are frequent companywide safety stand-downs, which are engineered to instigate vigilance, rather than fear. Annual performance assessments are conducted for each employee, where all areas of performance are assessed, including how the results were achieved. For example, lost time injury rates (LTIR) and fatalities form a significant element of the performance assessment, using both peer-relative targets and internal targets that are set higher than the peer averages. On the other hand, as far as environmental issues are concerned, such as number and volume of spills and hydrocarbon flaring, these are subject not to targets for measurement but to trends both relative and absolute which require continuous improvements.
As far as enforcement is concerned, “detrimental activity” does not merely refer to unethical behaviour, it also applies to accounting, health and safety, environmental issues, harassment, and the aforesaid conflicts of interest.For example, executives and directors are required to report questionable auditing to internal audit function and to the general auditor immediately. Exxon has a written open door policy for whistleblowers, along with a hotline if a superior is involved which goes straight to the corporate security department and/or human resources.

The company has clawed back awards of both stock and cash, and has, in most cases, successfully resisted any legal challenges to these actions because of the investigative and review process that is in place. While clawbacks have occurred, if an employee, for example, has fraudulently filled in a Health & Safety inspection form, termination is usually the outcome.
Exxon’s TSR is clearly in excess of its closest industry peers, but, as I have said, a more accurate measure of long-term value is ROCE, and on that measure as well, Exxon is outperforming its peers. But how much of this outperformance can be attributed to improvements in sustainability performance? This is a much harder question to answer.
Post-Gulf oil spill, BP has taken over from Exxon as the epitome of careless big oil. Exxon has appeared to cleaned up its act since the Exxon Valdez spill 24 years ago. I asked environmental risk assessment firm Trucost if this were true: its figures for Exxon’s impact ratio (total environmental costs/revenue) only go back to 2002, but would seem to confirm an improving trend. In 2002 it was 10%, by 2011 it had fallen to 4% – about industry average.
With all this in mind, I would not support ISS’s recommendation to vote against the Say on Pay resolution today. But given the amount of investigation I had to do to come to that conclusion, it would be unreasonable to criticise ISS’s conclusions – though Exxon’s explanation and defence of its own compensation policies would not seem to be making ISS’s job any easier.

Paul Hodgson is a partner at BHJ Partners