Allergan

Annual meeting: May 5

Both ISS and Glass Lewis recommended that shareholders vote against pay on the advisory vote at Allergan, for a number of excellent reasons. One prime example is the fact that, CEO Brenton Sanders received an extraordinary $20 million dollar bonus – but no equity awards – as part of his pay package.

However, I want to write today about a somewhat obscure and offensive elements of pay practices that was one rationale for the recommendation: the tax gross-up. (Skip the next five paragraphs if you know already know all you ever want to know about how tax policies are manipulated in favor of executives.)

The tax gross-up is often referred to in the shorthand of tax code jargon it was a response to, Section 280G, and it is a lesson on the unintended consequences of trying to reform pay legislatively. The creators of the rule had every good intention. They saw excessive severance packages and decided, essentially, “Let’s come up with a really costly punishment for executives and companies who have ridiculous obscenely high golden parachute severance packages for CEOs.” So an excise tax, a big extra tax, was set on any package over three times five-year average pay. Not only would the executive have to pay the tax, the company would lose the tax deduction.

Though three years of pay seems like more than enough to cushion a transition to the next job for most of us, it wasn’t enough for many executives. Severance packages grew, and language that seemed insignificant (let’s say “3 times salary and highest bonus instead of most recent bonus”), had significant consequences. Compensation consultations came up with a solution: the tax gross-up. Employment contracts began to include language that said that in addition to the severance payment itself, the company would pay taxes on the payment — or gross up the package –and taxes on the taxes, until the CEO was “made whole.”

The practice spread like wildfire, and for the most part shareholders were unaware of the cost or the extent of the practice. That changed in 2006 when enhanced disclosure required companies to estimate the costs of such packages. Following the revelations of the astonishing amounts involved, institutional investors pushed back. Some filed shareholder proposals, which gained support every year. When “say on pay” joined the scene, proxy advisory services identified the presence of such a loophole in an employment contract as a problematic practice and began voting against pay at such companies.

And nearly as quickly as it spread, the practice began to disappear. Company after company took such language out of contracts (sometimes giving executives an incentive to sign a new contract). The common formulation of “What we do” and “What we don’t do” proudly trumpeted the removal of the gross-ups.

It seemed as if reform was happening, but in some cases the reform was a mirage. There was nothing enforceable in these policy changes. Occasionally lately, we’ve noticed that when a merger takes place the board reverses its previous policy and adds gross-ups back in.

This brings us back to Allergan, and its own self-justifying support of the practice. As the now-cancelled merger with Pfizer approached, the company added the provisions to contracts. In an SEC filing disparaging the proxy advisors Allergan argues that they don’t normally have such tax reimbursement “arrangements in the ordinary course” but added them just for the upcoming merger. Now recall that such provisions are only triggered in a merger.

In other words, we’ll only put this bad practice on the books when it help our executives get more money.
I expect the vote against pay at Allergan to be high this year.