Today’s compensation committees—and the members of management who work closely with them—face a formidable task to develop and execute a compensation and benefits program that meets both management’s and investors’ expectations. In a regulatory environment that is becoming more and more complicated, ever-increasing scrutiny from shareholders and proxy advisors means that compensation professionals must be more meticulous than ever.
In April 2016, Equilar joined co-host Nasdaq at the MarketSite in New York City for the second installment of the Compensation Committee Forum. Compensation committee members, consultants and other key advisors provided their expertise to arm participants with the necessary knowledge to make the right pay decisions that are most relevant to their business and best drive their long-term strategy to increase shareholder value. This feature details the key issues and insightful quotes that highlight actionable insights to help compensation planners better processes and strategies to build the most effective pay packages and earn shareholder support while doing so.
Though the SEC has been in a stalemate after losing two commissioners in 2015, compensation-related rules from Dodd-Frank continue to be considered. Mandatory disclosure of the CEO to median employee pay ratio will be required beginning in 2018, and regulations around pay for performance and clawbacks were proposed last year and are expected to be passed once the SEC bench is replenished.
Aside from regulatory concerns, a wave of compensation-related litigation, including several 2015 lawsuits related to director pay, have made headlines and raised eyebrows from the corner office to the boardroom. While the director pay issue seems to have cooled, companies and their boards remain vigilant toward whether there will be another wave of shareholder lawsuits.
“Ultimately the new pay for performance disclosures will mean much longer CD&As, not only because of the required information but also because of the clarity that will be necessary. All of us are going to read another 10 pages of the CD&A.”
“Using TSR as your financial metric is same thing as teaching to the test.”
“If you target the median in the various markets you operate in, the CEO pay ratio is merely the function of where your employees are located. Companies are market takers not market makers when they go out to set pay. They can’t underpay in a hot market or overpay in a down market.”
“In the first year, the CEO pay ratio will not be comparable across companies. You’re only sharing one piece of information that’s not known—median employee pay, and half your employee population will realize they are below median. Everyone’s worried about the ‘four-digit pay ratio,’ unions will love it and use for negotiations, the media will love it to sell papers and magazines, and a lot of sound bytes from this will get amplified. But the real story will be how is it changing after one, two, or three years. Once you get longitudinal, there will be more insights that we can take from it.”
Ever-increasing shareholder scrutiny is forcing boards to make sure their peer groups are appropriate and defendable. Investors’ firsthand perspectives on the peer group selection process offer insights on how to select the most relevant peers and make the most of the process to drive strategic compensation decisions.
“More than anything, peer groups give us as investors a snapshot of the psychological makeup of the company and management. We use this kind of data as a mirror. It reflects on them who they think they are and who they really are.”
“Most of us don’t create peer groups, we inherit peer groups, and it’s more art than science. As chair of the committee, someone is going to look at your art, and if you can’t take that criticism, don’t be an artist.”
“Should peer groups be the same for executive pay as it for director pay? I think it’s the cleanest. Would be foolish to do otherwise.”
“There are some situations where companies may not pick a peer group—say they compete with divisions at other companies, and they would use surveys to look at the head of a division vs. the CEO. Or if they had gone through a merger or acquisition. But you don’t want to be changing it year over year because that can make it look like you’re changing to fit your compensation objectives.”
Because executive compensation design is a complicated process, it requires multiple stakeholders to make informed decisions that drive results and create shareholder value. Compensation committees must establish the most effective and beneficial relationships with their internal HR and compensation teams and outside compensation consultants and advisors to ensure the committee is prepared to make the best decisions related to executive compensation, talent management and succession planning.
“Talent has been given plenty of lip service, the idea that ‘people are our most important resources.’ In the last 10 years, it finally has ascended to the level of intensity it deserves, to the point where CEOs ranked talent as their number one issue in the past year. For boards and HR that means it should be a core agenda item.”
“Like they need audit, risk and tech experts, boards need talent experts. Management are leadership experts, but they don’t understand the mechanics of talent acquisition and retention.”
“Talent has risen to a level of sophistication today that HR executives need to act like a CEO of a talent solutions firm that has one client—their own company. We’re at a great inflection point to empower the HR function and raise it to sophistication and impact as a primary advisor to the CEO in terms of accessing human capital.”
“This is a partnership with three parties and has to be open and honest on the table. When you get into benchmarking and peer groups it’s not always clear the first time and you need to have iterations. If you get into a mode where you’re making decisions at the 11th hour, you’re going to create confusion and destroy trust.”
Since Say on Pay passed in 2011, companies have been pressured to become more transparent and forthcoming with the ways that they choose to pay executives, particularly the CEO. Aside from the official vote, shareholder proposals and proxy advisor scrutiny around pay for performance, equity approval and other pay elements often raise red flags.
“Bad compensation design leads to bad voting outcomes.”
“Management influences TSR, but they don’t control it, at least in the short term. TSR is a good measure for shareholders, but not really as an incentive metric.”
“There are three buckets we pay attention to in proxy statements—pay for performance, transparency around metrics and board oversight. Quality of disclosure, the structure of the process and how you tell your story is important.”
“Presentations in the proxy statements have gotten glitzier and companies are trying to sell themselves. Though it’s a compliance document, the proxy has also become a product brochure.”
Establishing goals that support the company’s long-term strategy and shareholder return is a critical component of the executive compensation planning process. While unique to every business, boards can achieve pay and performance alignment while supporting the appropriate level of risk-taking. In addition, forecasting goals in volatile markets and pitfalls to avoid when selecting metrics, as well as evaluating differences various industries and sized companies, are crucial when designing incentive plans.
“The retail environment has been incredibly competitive with fickle consumers and low overall growth. And the oil and gas industry is obviously facing serious challenges right now. Do you simply say, ‘There will be no incentive pay until or unless the company grows at a minimum rate?’ Or do you believe that the purpose of an incentive plan is to motivate the participants to achieve the company’s objectives and reward them for that achievement, which might not always result in growth?”
“Companies with well-defined long-term corporate strategies struggle the least with economic uncertainty.”
Shareholder engagement continues to be one of the hottest topics in board governance. As a result, directors need to establish proactive outreach to investors, including the right timing, who is involved and what makes meetings the most useful.
“Say on Pay has created much more open dialogue, not just discussing ‘what’ but also ‘why’ as companies try to balance the tension.”
“Over the past year, we’ve met with somewhere in the order of 800 companies, in 2016 that might hit 1,000. If you’re just getting in touch with us at the time the proxy is out, there’s not much you can do to change the facts. Tell your best story first in the proxy, which serves as a primary starting point for investors.”
“Comp committee members have a tough job if you fail Say on Pay. We got an unexpected red flag from ISS, caught on our heels, and realized we needed to do something. So we went out on the road and set up personal meetings in the offices of 40 of the top 43 institutional shareholders. We took no materials and wanted to hear them. Every single one of those were prepared to tell us things, and I heard some really interesting comments that were not compensation related but good for me to hear as a board member.”