Pollution Payday: Analysis of executive compensation and incentives of the largest U.S. investor-owned utilities

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American Electric Power

American Electric Power (AEP) is one of the nation’s largest investor-owned utilities, with customers in eleven states, including Arkansas, Indiana, Kentucky, Louisiana, Michigan, Ohio, Oklahoma, Tennessee, Texas, Virginia, and West Virginia. Target executive compensation at AEP for 2019 was 71% performance-based for CEO Nicholas K. Akins, and 12% base salary. The remaining 17% came in the form of time-vesting restricted stock units (RSUs) tied to AEP’s stock price. Broken down another way, long-term incentives were 72% of pay, annual cash incentives 16%, and base salary 12%.

Target compensation in 2019 for AEP’s other named executive officers (NEOs) was 61% performance-based, and 25% base salary. The remaining 13% came in the form of time-vesting RSUs tied to AEP’s stock price. Long-term incentives were 55% of pay, annual cash incentives 19%, and base salary 25%.

AEP’s long-term incentive compensation plan prioritizes operating earnings and shareholder return, but will also now award executives for new non-emitting generation 

AEP’s long-term incentive compensation is determined as follows, according to its 2020 proxy statement:

The number of performance shares earned at the end of the performance period is based on achieved performance against two equally weighted performance metrics: (i) 3 year cumulative operating earnings per share [EPS] and (ii) 3 year total shareholder return [TSR] relative to the companies in the Compensation Peer Group.” 

For 2020 to 2022’s long-term incentive compensation, AEP is adding a third three-year performance measure for “new non-emitting generation capacity measure with a 10% weight.” The TSR performance measure has been reduced from 50% to 40%.  

AEP defines non-emitting generation as “nuclear, hydro, wind, solar, [and] demand-side management and storage.” The company said the new measure “was chosen to align with its strategy to commit substantial investments that reduce greenhouse gas emissions.” 

The incentive would not discourage AEP from adding carbon-emitting generation, however: AEP recently told investors that it plans to add 1,607 MW of new natural gas, a fossil fuel that emits CO2, to its generation mix between 2020 and 2030. 

Annual incentive compensation plan for AEP executives prioritizes operating earnings over customers, diversity, and decarbonization 

Annual incentive compensation for AEP executives was based on performance metrics weighted as follows in 2019: operating EPS at 70%, strategic initiatives at 20%, and safety and compliance at 10%. The strategic initiatives category includes infrastructure investment at 9%, cost control at 4%, customer experience and quality of service at 4%, and “culture and workforce of the future” at 3%.

“Culture and workforce of the future” includes employee diversity, weighted at 1%. Employee diversity is measured by increased “representation of women and minorities in EEO (Equal Employment Opportunity) categories.” 

Subcategories for compliance metrics included environmental stewardship weighted at 1%.

“This measure was based on the number of significant environmental enforcement actions during the year (those resolved with a fine exceeding $1,000),” according to AEP’s 2020 proxy statement, which noted the company had no significant enforcement actions in 2019 – so it would appear to have rewarded AEP executives for following the law.

AEP has goals for reducing its carbon dioxide emissions by 70% by 2030, and 80% by 2050 from 2000 levels. The utility also has an “aspirational goal” of zero CO2 emissions by 2050, and its executives have described how meeting that goal would require achieving 100% renewable energy.

In 2019, executive performance metrics for strategic initiatives included measures of success in “developing a multi-state regulated renewable project, contracted renewable power project investment in our competitive subsidiaries and efforts to develop regulated renewables or distributed generation for large customers.” These measures were weighted at 5% of the overall performance metrics.

AEP’s renewable goals appeared to have been easy for the company to reach: AEP reported $1.28 billion in contract commitments for renewables, which exceeded its target of $250 million and maximum performance goal of $325 million by factors of approximately five and four, respectively. In 2018, AEP included “projects reaching commercial operations” in this metric for contracted renewables portfolio growth, but apparently dropped that performance measurement for 2019.

AEP further lowered the bar for executives in 2019 by measuring performance on renewables based on regulatory applications filed, rather than on projects approved by regulators. AEP reported filing regulatory applications for its North Wind Central Wind Project, representing 1,485 MW of regulated renewables, which exceeded its executive performance target of 900 MW, but fell just short of the maximum target of 1,500 MW.

AEP previously established executive performance measures for 2018 based on regulatory approvals for its major Wind Catcher project and regulated renewables for Appalachian Power, but executives scored zeroes on both of these measures. The current North Wind Central Wind Project serves as a replacement for the multi-state Wind Catcher project, which AEP canceled in 2018 after it was rejected by regulators in Texas. AEP says it plans to move forward with the new project with or without approval from Texas, and has already secured approval from the other states involved in the project.

AEP executives also hit their performance target of filing just one regulatory application for customer targeted regulated renewables in 2019, short of the maximum target of two applications included in its annual incentive compensation metrics.

AEP’s executives benefit from performance measures that exclude key factors impacting the utility’s earnings  

AEP uses operating earnings, a non-GAAP (Generally Accepted Accounting Principles) financial measure that excludes certain items that may negatively affect its bottom line, as a component of executive compensation.

“For 2019, GAAP earnings per share were $3.89, which is $0.35 per share lower than operating earnings, which is used as a metric when awarding executive compensation,” according to AEP’s 2020 proxy statement.

The proxy statement points to an earlier 8-K filing from the company, which provides a comparison of AEP’s GAAP earnings to its operating earnings. It shows a number of “special items” excluded from operating earnings used to award executive compensation, including: mark-to-market impact of commodity hedging activities, severance charges, acquisition fees, previously retired coal generation assets, Conesville impairment, and Texas base rate case.

“The difference between fourth-quarter 2019 GAAP and operating earnings was largely due to the expensing of previously retired coal generation assets in Virginia, the recently filed settlement in the Texas base rate case and the Conesville Plant impairment,” according to the 8-K.

AEP’s use of non-GAAP accounting to exclude the effect of retired coal generation assets on earnings when determining executive compensation may have benefits for customers if it helped to avoid a compensation penalty that would discourage executives from deciding to retire those polluting assets. Earnest, robust incentives that align compensation with decarbonization goals (see “Misalignment with Decarbonization”) would also help to neutralize any penalties that executives might face from retiring or abandoning fossil fuel assets, and to discourage them from investing capital in those projects in the first place. AEP does not have incentives that directly reward its executives for decreased carbon emissions.

A more recent 8-K filed by AEP in May 2020 also said, “The difference between first-quarter 2020 GAAP earnings and operating earnings was due to the mark-to-market impact of economic hedging activities and certain expenses related to the COVID-19 pandemic.” It is also listed “COVID-19 charges” among the special items excluded from operating earnings for Q1 2020.

Directors get a $5,000 bonus for serving on AEP’s Policy Committee, despite misalignment of utility’s policies with decarbonization and renewable energy goals

Directors who serve on AEP’s Policy Committee receive an additional $5,000 annual retainer. “The Policy Committee is responsible for examining AEP’s policies on major public issues affecting the AEP System, including environmental, technology, industry change and other matters,” according to AEP’s 2020 proxy statement.

Those policies include supporting subsidies for coal plants in AEP’s home state of Ohio, and supporting the Trump’s administration’s rollback of the Environmental Protection Agency’s limits on CO2 emissions from power plants.

Some of American Electric Power’s customers pay for incentives that benefit shareholders 

American Electric Power’s customers in Indiana pay for a multi-million dollar slice of the utility’s employee and executive incentive compensation plans.

Indiana Michigan Power, a subsidiary of AEP, sought to include $23.7 million for annual incentive plan costs in its rates, and to recover $6.98 million in long-term incentive program costs from customers as part of its latest rate case in Indiana.

Mark Garrett, an expert witness who testified in the rate case on behalf of the Indiana Office of the Utility Consumer Advocate, recommended that the Indiana Utility Regulatory Commission (IURC) disallow Indiana Michigan Power from recovering any of the long-term incentive program costs from customers. Garrett also recommended allowing the utility to include only 50% of the annual incentive program costs in rates, although he said “a 70% disallowance would be justified” in his testimony. He pointed out that 70% of AEP’s annual incentive plan is based on the utility achieving an EPS target.

“Less than 30% of the plan’s metrics relate to safety, customer satisfaction and reliability,” Garrett said.

AEP’s annual incentive plan is also “structured to benefit its highly compensated senior level employees more than its rank and file employees,” Garrett said.

Garrett warned that: 

AEP’s plan is designed to place shareholders’ interests first—that is, the Company will ensure target shareholder earnings levels are satisfied before employees are paid any incentive compensation. From a ratemaking perspective, this means that money collected from ratepayers for the purpose of paying employee incentives may not be paid to employees but instead may be diverted, if needed, to bolster shareholders’ return on investment.” 

Garrett shared the results of a survey of twenty-four western states, which found that “most states follow the general rule that incentive pay with financial performance is not allowed in rates.”

The IURC’s 2020 order in the rate case sided with the utility, and declined to adopt the recommendations of the Indiana Office of the Utility Consumer Advocate. 

In contrast, “[t]he Oklahoma Corporation Commission disallows 100% of AEP’s long-term executive incentive plans,” Garrett noted in his testimony. 

Oklahoma also disallows 50% of AEP’s annual executive incentive plan costs from rates. 

In 2020, AEP filed an application to increase rates with the Public Utilities Commission of Ohio in which it also asked to recover costs of executive incentive compensation from ratepayers.

CEO compensation ranking among utilities studied, 201911/19
Compensation ratio: CEO to median employee, 2019109:1
Percent change in CEO compensation, 2017-2019+25.7% ($2,961,975)
Maximum payout of performance-based shares as a percentage of target, 2019200%
Is AEP’s executive compensation structure aligned with decarbonization?Not directly. Renewable energy development and investment accounted for 5% of the performance measures tied to annual incentive awards for executives in 2019. No incentives directly reward decreased carbon emissions.
Is there evidence from SEC filings that AEP is using misleading financial metrics to determine executive compensation?Yes. AEP employed non-GAAP accounting measures to exclude a number of factors, including mark-to-market impact of commodity hedging activities; severance charges; acquisition fees; previously retired coal generation assets; Conesville impairment; and Texas base rate case.

AEP’s use of non-GAAP accounting to exclude the effect of retired coal generation assets on earnings when determining executive compensation may have benefits for customers if it helped to avoid a compensation penalty that would discourage executives from deciding to retire those polluting assets.
What key perquisites or benefits do AEP executives receive?The CEO is allowed up to 40 hours of personal use of corporate aircraft each year, but must reimburse the company for the cost. Other perks include third-party gifts and sponsorships and charitable gift matching.