Banoff

By Jeremy Banoff

The issue of executive compensation has been widely publicized—and in many cases, criticized—for several years. Most recently, media attention has focused on the recent implementation of the new Securities and Exchange Commission (SEC) proxy disclosure rules and the ongoing debate surrounding the "say-on-pay" bill (formally known as the "Shareholder Vote on Executive Compensation Act") that was passed in the House of Representatives in March 2007.

While countless column inches and minutes of on-air time have been devoted to the complexities of executive compensation across corporate America, the real estate industry has yet to garner much attention on the matter. Could it be that the real estate industry has appropriately aligned pay with performance?

Real Estate: Ahead of the Curve?

In many regards, the REIT industry has been at the forefront of compensation program design compared to the rest of corporate America. For example, restricted shares have been an important component of long-term incentive programs in the public real estate industry for many years.

Five years ago, NAREIT's 2002 Executive Compensation & Benefits Survey found that more than 75 percent of participants used restricted stock. Notably, the majority of these REITs made grants contingent upon the achievement of various performance criteria, most often related to total shareholder return.

In more recent years, changes in accounting rules and options backdating scandals have led other industries to the more widespread use of restricted stock (and a commensurate move away from options). Another reason for this shift is the growing perception that restricted shares align executives' interests with those of shareholders more effectively than do options.

Many constituents believe that ownership of restricted stock puts executives in the same boat as shareholders and encourages them to focus on increasing the longer-term value of their equity. While options may lead to decisions that only temporarily drive up share price, enabling executives to cash out their options, but that may not be in the best long-term interest of the company.

Real estate companies also set the bar in pioneering the use of multi-year, long-term incentive programs. Such programs base compensation on longer-term performance, typically over a three-year period. While only a handful of these programs were in place several years ago, the 2007 NAREIT Compensation Survey showed that approximately 45 percent of participants are using some variation of a multi-year program.

Basing pay on a multi-year performance period makes sense in the real estate industry because it generally takes several years for real estate investments to come to fruition. Recently, a few companies outside the industry have implemented similar programs based on multi-year performance. However, the idea is gaining traction slowly.

New Proxies Give More Detail

While linking compensation to performance has been common in the real estate industry for some time, new proxy rules are having a noticeable impact on how compensation is reported.

The new "Compensation Discussion and Analysis" (CD&A) section has greatly enlightened shareholders by requiring companies to provide more detail with respect to their process of setting and determining compensation.

Generally speaking, the real estate industry is working hard to adhere to both the spirit and the letter of the new rules. In FPL Associates' recent analysis of the 100 largest public real estate companies, over 80 percent of companies disclosed specific performance criteria for their incentive compensation programs. A good portion of the remaining 20 percent discussed various performance criteria that may play a role in the level of bonus awards.

One of the many new requirements of this year's proxy filings is the definition of the cash bonus award either as a bonus, for which there is no pre-determined formula determining for the amount of the award, or as non-equity incentive compensation, which is determined on the basis of an objective formula.

Among the top 100 companies, close to 60 percent report compensation under the non-equity incentive compensation column, signifying a strict pay-for-performance policy. This is not to say that the remaining 40 percent do not consider performance when determining bonus amounts. Rather, they simply take more of a discretionary approach.

Now that this disclosure is required, even more companies may move to a non-equity incentive approach to underscore their commitment to pay-for-performance policies.

This year's proxies also showed that compensation programs are more heavily weighted towards long-term compensation than ever before. For the first time since the study's inception five years ago, long-term compensation accounted for more than 50 percent of total compensation for executive officers.

Given that long-term compensation is almost always tied to the performance of a company's stock, it appears that the REIT industry's alignment of executive interests with those of shareholders is well intact.