The Directors Roundtables: Strategies for CyberSecurity, CEO Share Grants & Activist Buy In

January 2, 2018

How do boards navigate cybersecurity issues when relocating or expanding business?

How do they address executive share grants when the company’s stock price is declining?

How do directors get buy in from activist shareholders?

Directors & Boards recently convened The Directors Roundtables where top corporate board members and experts in cybersecurity, compensation, and corporate activism put their heads together to come up with strategies and best practices for some the biggest challenges facing the nation's board rooms today. The Roundtables use hypothetical board situations as launching points for in-depth discussion among participants.

Experts on hand to facilitate the discussions were from AlixPartners, Pay Governance, and Agility Executive Search.

Here's an excerpt of the topics and a glimpse at the takeaways that came out of the roundtable discussions:

Security, for the Win

Moderated by AlixPartners

The Case

Directors considered the cybersecurity risks associated with the potential acquisition of a fintech company. The target company had a security breach two years ago and has provided a roadmap that includes incorporating data from social media to enhance business insights, moving to a cloud-based offering, offshoring maintenance and minor enhancements to Ukraine, and moving its call center to Utah.

Key Takeaways

• Retain a cybersecurity expert: Evaluate cyber risks and have someone who understands the business of the target company on hand.

• Reputational risk is a key concern: Several attendees felt this was the most important consideration of risk and discussed how to put a price on reputation damage.

• Defining the role of the board vs. management: Many board members felt they needed the details for context, even if company management is responsible for digging deeper; the board is responsible for examining the information available and asking the right questions. There’s also a need to determine the impact of regulations on the board’s liability. Directors need to learn the appropriate sources of data from which information about risks could be gathered.

• Assess and put a value on the risk: Gather the necessary information to understand risk and future posture of the target company and to make an informed decision as to whether to move forward with the acquisition. Consider existing risks, risks related to the integration effort, risks associated with the acquisition’s strategy and risks related to the change process to accomplish the strategy objectives. This could include information about the target company including vendor ecosystem, backlog of known vulnerabilities, process maturity, previous third-party vulnerability assessments, etc.

Examine IT and business factors that may impact cyber risk. Consider the strengths of the acquirer, which may serve to mitigate some of the risks.

• Evaluate and determine acceptability of risk: Determine if an upfront investment to mitigate risk and to make sure that the process/ standards match those of the acquirer will pay off in the end. Look at the vulnerability and technical debt of the target. Determine how much debt the acquirer is willing to take on, and at what point the risks become a showstopper. Consider what the integration plan will look like. Estimate potential damage and the cost to recover from a security incident.

• Balance risk against acquisition upside. Consider the cost and risk of building vs. buying. Look at the source of the deal and the target company’s competitors. Determine how integral the target company is to the acquirer’s business strategy and the effect of passing up on the deal. Evaluate how much investment makes sense to promote future revenue growth.

How Many Shares Should the Comp Committee Grant to Management?

Moderated by Pay Governance

The Case

How many shares to grant to management when the company’s stock price decreases significantly? A company’s stock price had fallen to $10 per share from $40 per share the previous year, a decrease of 75%. In order to deliver the same long-term incentive value as the previous year, the committee would need to grant the CEO 400,000 shares instead of the 100,000 granted one year earlier.

Key Takeaways

Committee should evaluate the impact of the share grant increase on:

• Expected life of the Equity Incentive Plan share reserve. Are there enough shares in the plan to accommodate the increased share grants? If maximum performance share awards are earned, is the individual maximum share limit exceeded? Will such a large increase in share grants deplete the share pool prematurely requiring shareholder approval for a new share request sooner than anticipated?

• Burn rate calculations related to industry and peer standards. How many shares would the grant require as a percent of total shares outstanding? How does this percentage compare to historical grants and industry and peer usage? Would this be perceived as excessive by shareholders?

• Potential gain to executives associated with the grant. What would the value of the share grant be should the company’s stock price increase back to its previous level of $40? Would this be viewed as excessive of a windfall by shareholders?

What are some of the issues to consider when determining whether to grant the calculated 400,000 shares or take action to reduce the share grant?

• What is the current share ownership of the executive team? How much wealth has been accumulated? Have executives been selling shares? Have performance awards been earned above target over the past several years?

• What are the dynamics of the executive team? Is the team seasoned and highly tenured? Is the team largely less tenured with low stock ownership?

• Has retention been an issue and has the company successfully attracted high performing executives? Have executives left the company for other positions over the past several years at an above normal rate? Are there examples of successful recruiting of high performing executives?

• How strong is the company’s succession plan? Is there adequate depth to replace current executive talent? Would the loss of an executive result in the need to recruit externally and therefore pay a recruiting premium?

• How generous is the current executive retirement plan? Is there a legacy defined benefit plan still in place? How stringent are vesting provisions?

• What would be the impact on the fair value of the equity award should shares be reduced? Would executives view this as a takeaway or would they understand the potential gain?

• Based on historical stock price trading patterns, how soon is the stock price likely to recover to prior-year trading levels? How volatile is the stock price? Is it likely to recover within the next couple of years or is it likely to be even longer (i.e., 5 years)?

• Has the company had previous Say on Pay support issues? Have prior year voting results been strong or have they been lacking? Has there been critical proxy advisor feedback on the compensation arrangements? Should the determination be made to reduce the share grant, several methodologies exist to make the decision less arbitrary.

• Adjust the targeted long-term incentive value lower. The committee could target the peer group 25th percentile or reduce the previous year’s grant value by 20% to 40%.

• Adjust the stock price used to calculate share grants. A long-term average stock price could be used to determine share grants such as the 90- or 180-day average.

• Limit the increase in shares granted by a certain percentage. Grants could be made to limit the increase of the current year grant to 25%, 50%, or 75% more than the previous year’s grant.

• Grant the same number of shares as the previous year. This approach is similar to the fixed grant approach used by many companies a decade ago. This approach would result in the largest decrease in fair value.

An Activist Shareholder Buys In

Moderated by Agility Executive Search

The Case

A mid-cap apparel retailer has declining sales. While the company is starting to make some improvements, they will take some time to be implemented and become effective. An activist investor has recently disclosed a 6% ownership in the company and will be looking for change and progress.

Key Takeaways

• Not just a burden: Activist investors are a significant and increasingly important asset class. They identify companies with unrealized value that they believe can be unlocked.

• When to prepare? “Yesterday.”: This preparation is multi-faceted and should involve the board, outside counsel and public relations experts at the very least.

• Know your vulnerabilities: When an activist investor shows up in a particular company’s stock – it should not be a surprise.

• Communication is key: Boards need to communicate with shareholders and try to understand what they are thinking and/or concerned about.

• Hear them out: The company should also be receptive to a conversation with an activist who has invested in their company.

• All activists are not the same: Some are better than others; some are more shortterm; some more constructive.

• Benefit from the research, show caution: We can learn from the analysis the activists undertake and the white papers they create. But not everything they say is the right or best thing for the company. Don’t assume they know everything or, conversely, that they know nothing.

Want to be part of a roundtable and get valuable advice from corporate governance experts first hand? If you sit on a corporate board and would like to attend a future Directors & Boards' Directors Roundtables please email David Shaw at dshaw@directorsandboards.com.