Conclusions
While executive compensation is subject to considerable external scrutiny, and any compensation committee is potentially at risk for criticism regarding their decisions, we believe that executive compensation is a key tool that — when used correctly — can help an organization achieve its goals. When the pay design goes awry, however, pay levels can become a distraction for members of the board and the management team.
Key Lessons
Our position as compensation advisors has provided us with a unique vantage point to view the evolution of the role that compensation committees play within an organization. While in the past, the committee may have been too closely aligned with management, today’s committees take their independence and objectivity seriously. What many critics of executive compensation practices fail to understand is that even with the best intentions, it is almost impossible to create an effective compensation design that will be embraced by everyone. Compensation committees must balance competing objectives in compensation design and prioritize the concerns of the many different constituencies that will weigh in on said design, whether their input is solicited or not.
Some of our peers in the consulting profession have raised concerns that executive compensation practices run the risk of evolving over time to a “one-size-fits-all” approach. They fear that, due to the disproportional influence of shareholder advisory firms on executive compensation design, compensation committees will cave to compensation designs dictated by the policies of these firms. For example, since ISS uses total shareholder return (TSR) as a key component in its pay-for-performance model, the risk is that compensation committees may move to long-term incentive designs based on relative TSR to mimic ISS’s quantitative tests. Similarly, a compensation committee that is overly concerned with ISS may select peers based less on their own definition of the competitive market for talent and more on the basis of whom ISS views as appropriate peers.
We believe these fears are overstated. We agree that ISS and Glass Lewis tend to evaluate compensation programs using a “one-size-fits-all” approach that may fail to recognize that organizations might have good reasons for using compensation designs that do not comply with their policies. However, in our experience, compensation committees function as an effective bastion against the prescriptive policies of shareholder advisors. Most of the committees we see in action recognize that ISS and Glass Lewis are influential over a portion of the company’s shares, but in most cases only influence the voting of a minority of shareholders. The committee understands that doing something only for the purposes of pleasing ISS can significantly diminish the effectiveness of the compensation program in achieving its objectives as an overall management tool.
For example, many companies continue to use the same performance goals in both their short-term and long-term performance plans. ISS and Glass Lewis each view this as a problematic pay practice that puts excessive weight on a single performance measure. However, compensation committees recognize that while ISS and Glass Lewis may have a point in certain circumstances, there are plenty of situations where using a single measure for both the short-term and long-term performance plans makes a great deal of sense. For example, many companies that use economic profit as a performance measure will use it in both the annual and long-term performance plans. Organizations that use economic profit effectively understand that using other performance measures will dilute the company’s focus on its true definition of performance. Compensation committees in such an organization would need to work to ensure that other aspects of the compensation program address the concerns of shareholder advisors.
Successful committees do a great job of balancing the concerns of multiple constituencies. They will pick their battles with shareholder advisers or with management over fundamental principles that the committee views as critical to the compensation design. Wisely, committees will cede ground on more minor points that may run against the committee’s preferred approach but will ultimately help the committee win other battles with management or shareholder advisers elsewhere.
Looking Forward
If we scroll forward to what the next few years hold for compensation committees, we expect to see a continued movement toward more effective review and refinement of the pay-for-performance relationship. We expect that it will be standard practice for compensation committees to conduct an annual evaluation of the prior year’s compensation to see how well the company’s pay levels aligned with the company’s performance. While many compensation committees already do this today, we expect to see a higher degree of sophistication in the future with compensation reviewed not just from the perspective of the Summary Compensation Table, but also from the perspective of realizable pay. We also expect committees to review the pay-for-performance relationship over a three- to five-year period, in addition to a year-over-year look at compensation changes. Sophisticated committees will review the company’s performance from multiple perspectives beyond total shareholder returns to examine top-line and bottom-line growth, as well as financial returns on capital.
While a retrospective review is important for understanding how well the pay program has worked in the past, in order to ensure the program works well going forward, the selection of performance measures linked to forward-looking strategic objectives and shareholder value creation will be critical. Compensation committees need to ensure that management uses performance measures in the annual and long-term incentive designs that effectively measure success against strategic objectives and implementation of such objectives.
Beyond selecting the right performance metrics, the committee and management must work together to make sure that goals are set at the right levels to satisfy both internal and external stakeholders. Many companies rely heavily on an internal budgeting process to establish performance objectives. This approach can lead to goals that fall short of external expectations for performance. Management and the compensation committee should review shareholder expectations for performance along with peer historical performance levels to assess the rigor of budgeted performance levels. Shareholders are likely to be underwhelmed if the company achieves its internal performance objectives but falls short of industry standards. Setting performance goals with adequate rigor will be a leading contributor to appropriate pay-for-performance connections in the future, along with incentive vehicles that provide appropriate linkages to shareholder value creation.
To date, the annual Say on Pay vote has been a non-issue for most companies with very high approval rates. However, there has been an enhanced focus on shareholder outreach and engagement with shareholders on the subject of executive compensation. We expect this trend to continue in the future. At times, committee chairs will be called upon to speak directly with shareholders to explain the rationale for the company’s compensation decisions. This type of communication, when combined with the clear disclosure in the CD&A, can help to keep the Say on Pay vote a non-issue.
We hope that this book has provided helpful guidance on compensation committee processes that can help you to be successful in your committee service. We believe that this book can serve as a valuable reference tool to provide you with a baseline understanding of key aspects of compensation design.
Authors and Editors
Eric Hosken, Partner
[email protected]
Eric Hosken is a Partner at Compensation Advisory Partners LLC (CAP) in New York. He has over 25 years of executive compensation consulting experience working with senior management and compensation committees on all aspects of executive compensation, including total compensation review, annual and long-term incentive design, performance measurement and director compensation. He has worked with public and private companies across multiple industries, including financial services, manufacturing, professional services, pharmaceutical and telecommunications. Eric is a frequent speaker on executive compensation topics and has written articles for numerous publications, including CNBC.com, Executive Counsel, HR People & Strategy and WorldatWork’s workspan.
Bonnie Schindler, Partner
[email protected]
Bonnie Schindler is a Partner at CAP in Chicago. She has over 30 years of combined experience in consulting, human resources, and human resource communications. Bonnie helps clients design and communicate compensation programs for executives, boards of directors, and employees. Bonnie works in a variety of industries, including financial services, technology, manufacturing, and professional services. In addition to working with public companies, she works extensively with privately-held and family-owned businesses and with tax-exempt organizations. Bonnie co-leads CAP’s private company research surveys and is a certified executive compensation professional (CECP), as designated by WorldatWork.
Assistant Author and Editor
Grace Tan
Grace Tan is a Senior Analyst at CAP in New York. Grace has co-authored and provided research to CAP’s research reports on executive compensation trends, such as annual incentive and long-term incentive payouts, moonshot awards, and long-term incentive goal disclosure. Her research for CAP has been published by Agenda and the Harvard Law School Forum on Corporate Governance.
Our Partners
Shaun Bisman, Partner
Shaun Bisman is a Partner at CAP in New York. He has over 15 years of experience consulting to management and compensation committees. Shaun provides compensation consulting services to both public and private companies, assisting with corporate governance, peer group development, performance measurement, pay-for-performance validation, incentive plan design, and director compensation.
Melissa Burek, Partner
Melissa L. Burek is a Partner at CAP in New York. She has over 25 years of experience, consulting with CEOs, boards, and company management. She has significant experience in the insurance, automotive and consumer products industries. She consults in all areas of executive compensation, including strategy, incentive plan design, performance measurement linkages, governance/regulatory issues and director compensation. She has overseen best practices studies with Fortune 100 companies and is a frequent speaker on executive compensation issues and trends.
Peter T. Chingos, Partner Emeritus
Peter T. Chingos is a nationally recognized executive compensation consultant and is a Partner Emeritus at CAP in New York. He consults with CEOs, boards of directors, and company management in all major industries on a wide range of executive compensation and human resources issues.
Margaret Engel, Partner
Margaret Engel is a Partner at CAP in New York. She has provided board and management executive compensation consulting services for over 30 years. Margaret has broad experience, with particular experience in retail, consumer products and telecom industries. She has consulted in all aspects of executive compensation and program design, including IPOs, mergers, spin-offs and other corporate transactions. The chapter on compensation in mergers and acquisitions is based on an article Margaret wrote for CAP.
Dan Laddin, Partner
Dan Laddin is a Partner at CAP in New York, with approximately 25 years of experience consulting to management and compensation committees, prior to which he was a CPA. He works with Boards and management, consulting in all areas of executive compensation, including annual and long-term incentive design, performance measurement, target-setting, regulatory issues/compliance, as well as outside director compensation programs. He has experience working with both private and public companies across industries.
Kelly Malafis, Partner
Kelly Malafis is a Partner at CAP in New York. She has over 25 years of executive compensation consulting experience working with compensation committees and senior management teams. Kelly has worked with both large and small publicly traded companies across a variety of industries, consulting on all areas of executive and board of director compensation. Kelly has also provided advice on compensation issues for privately-held companies and companies with special circumstances such as spin-offs and IPOs.
Lauren Peek, Partner
Lauren Peek is a Partner at CAP in New York. She has over 15 years of experience in advising compensation committees and senior management on executive compensation strategy development, evaluating pay and performance relationships, annual and long-term incentive plan design, board of director compensation, the proxy and CD&A, and corporate governance issues.
Rose Marie Orens, Partner Emeritus
Rose Marie Orens is a Partner Emeritus at CAP in New York. She has consulted on executive and director compensation issues for over 20 years, with a focus on tying executive compensation to business strategy and enhancing the linkage between performance measurement and rewards. She specializes in working with company management, compensation committees and boards across industries, with particular expertise in the financial services industry.
Susan Schroeder, Partner
Susan Schroeder is a Partner at CAP in Los Angeles. She has more than 25 years of experience advising Boards and company management on compensation strategies, performance measurement customization, and short and long-term incentive plan design. Susan’s experience includes work for Fortune 500 companies as well as smaller public, private, and not-for-profit organizations across many industries, including commercial and investment banking, investment management, manufacturing, professional services, real estate, and technology. Over the years, Susan has developed a particular expertise in developing incentive plans that reward for long-term value creation where publicly traded stock is not available.
Matthew Vnuk, Partner
Matt Vnuk is a Partner at CAP in New York. He has 20 years of experience advising boards and management in all areas of executive and director compensation, across a wide range of public and private companies, with a focus on the high-tech companies, as well as the insurance, payment processing, manufacturing and apparel industries. Matt is a frequent speaker on executive compensation topics and has been quoted by or written articles for numerous publications, such as Agenda, Corporate Board Member, Directorship, Fortune, WorldatWork’s workspan and The Wall Street Journal.
Compensation Advisory Partners (CAP) is a leading, independent executive compensation consulting firm. We specialize in executive and director compensation and related corporate governance matters. Our consultants serve as independent advisors to boards and senior management at many leading publicly traded companies. Since being founded in 2009, CAP has helped hundreds of clients with compensation strategy and pay program design, while ensuring sound corporate governance principles. We work across industries, and with publicly traded, privately held and tax-exempt entities of all sizes.
Please contact us at (212) 921-9350 [email protected] if you have any questions about the issues discussed in this book or wouldlike to discuss your own executive compensation issues. You can access our website atcapartners.com for more information on executive compensation.
A Practical Guide to Compensation Committee Service: Lessons from the Field
Third Edition