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To Best Align Pay Incentives-Strategy, Consultants Suggest Three-Step Protocol
In designing compensation programs, companies should ensure their incentive structures reinforce, rather than undermine, their business strategies. Incentives are a prime opportunity to indicate to employees why the company is choosing to pursue long-term investments over short-term profits or vice versa.
Said Jim Heim, Managing Director of Pearl Meyer & Partners, “If you do this right, you can actually find yourself in this positive feedback loop where, because employees better understand what they’re trying to accomplish, they’re actually able to accomplish it.”
However, although business strategy usually is pegged to financial indicators, there may be times—such as industry disruptions—when companies must undertake decisions that sacrifice immediate financial results, said Theo Sharp, also a Managing Director with Pearl Meyer.
Because business is in a constant state of flux, companies must periodically assess not only their strategic imperatives, but also their financial imperatives such as generating enough cash to pay their workforce and to fund investments.
Said Sharp, “We suggest that compensation committees go through an exercise like this every year when they’re designing their incentives to be sure that something hasn’t shifted slightly one way or the other that will cause them to move up or down the scale.”
Bloomberg BNA, Workforce Strategies—Dodd-Frank: The Current State of Executive Compensation Compliance
Dodd Frank Puts Spotlight on Executive Compensation
What is the true impetus for legal and regulatory changes around the practice and disclosure of executive compensation? The overriding themes for publicly held companies updating their best practice approach to executive compensation are transparency to shareholders and accountability for the executives themselves, consultants versed in the field agree.
However, Managing Director for Pearl Meyer & Partners, Deborah Lifshey was somewhat critical of ISS and Glass Lewis’s ‘‘one-size-fits-all approach.’’ She explained that these proxy advisory services ‘‘issue recommendations on what are good or bad compensation practices—points they consider to be good or bad practices—and recommend to shareholders whether they should vote for or against the company’s compensation program. Boards of directors and compensation committees feel compelled to check all the boxes when the practices they lay out are not necessarily the best, and could result, in the worst case, in management leaving for the private sector.’’
April 25, 2015
Top-paid Healthcare CEOs See Pay Grow
Total compensation for some of the highest-paid CEOs in the healthcare industry increased faster than their companies' profits last year, a Modern Healthcare analysis of the first firms to report executive pay found.
Increasingly, companies use performance—rather than simply length of time since the grant of stock or options—to determine whether executives can cash in on these awards. Performance measures are applied not only to one-time awards, but more commonly to vesting annual equity payouts as well, said Steven Sullivan, Vice President at Pearl Meyer & Partners, a compensation consulting firm. “Performance shares are kind of everywhere.”
February 20, 2015
Investors: Proxies Are Too Long and Complicated
Companies are failing to effectively communicate executive compensation in proxies according to a new study by the Rock Center for Corporate Governance at Stanford University. Boards are being advised to take a fresh look at compensation disclosures, take more time to write them and use simpler language to make them easier to read.
Sharon Podstupka, Vice President at Pearl Meyer & Partners, says a common thread among companies with effective CD&As is that the comp committee sets out the planning process and tone for the disclosure well before the close of the fiscal year. Podstupka advises companies to start their CD&A content development earlier and suggests a time frame of three months before the end of the fiscal year.
Boards and management may also want to bring in an outsider to write the proxy to make it clearer. “[Attorneys] play a critical role, but having them partner with different kinds of writers to help streamline and make content easier to read can provide a clearer outcome,” Podstupka adds.
Pay and Responsibilities Rise for Directors
‘‘The role of the director is arguably more complex than it’s ever been,’’ said Brett Herand, executive compensation consultant and Vice President at Pearl Meyer & Partners. Companies and investors expect more from their boards and expectations and the degree to which directors are scrutinized have never been higher, he said. ‘‘Directors must ensure their knowledge base remains current on issues that they haven’t had to face in the past—cyber security, activist investors, a 24/7 news cycle, new players in a global business environment, government regulation, etc.,’’ Herand said.
Following the recession, there was some pent-up demand to review and adjust pay levels for directors, according to Herand. “We’ve had several years of pay increases in the midsingle digits. Current pay adjustments reflect a more normal course of business,’’ Herand added.
January 26, 2015
When to Deviate From ISS's Policies on Comp
Compensation committees are being advised to be mindful of proxy advisory firms, particularly ISS, but not to forget that compensation design should be tied to business strategy.
Deborah Lifshey, Managing Director in the New York office of compensation consultancy Pearl Meyer & Partners, said in a recent National Association of Corporate Directors webcast that there is a tendency to focus on ISS because it is the proxy advisory service with the most influence over institutional shareholders.
ISS typically recommends voting against 10% of the plans put on ballots, lowering the passing rate by 23% to 26%, so it has an impact. “But the impact is not determinative of the voting outcome,” Lifshey said.
Shareholders went along with ISS recommendations in only 17% of those votes.
“So getting an against vote from [the proxy advisory firm] is bad, but it is not death,” Lifshey said. “You can get around [it] by trying to do some shareholder outreach, looking at your other major shareholders and appealing to their policies if they are not strictly following ISS.”
Steven Van Putten, Managing Director at Pearl Meyer & Partners, said in another recent webcast carried out in conjunction with the NACD that often one of the first questions a client asks is if the incentive program will raise a flag with ISS, Glass Lewis and other shareholder advisory groups.
“It is not to say that those aren’t important considerations, but it is how those considerations are used in determining compensation program design. Our view is that it should inform program design, but it should not necessarily dictate how the compensation program is structured,” Van Putten said. “Rather we believe that business strategy and leadership strategy should be the key drivers of compensation philosophy, which in turn drive program design and get delivered in terms of results.”
January 13, 2015
Working with Pay Consultants and HR
A look at why collaboration on the executive compensation plan is essential and how giving consultants more say over the compensation committee's agenda can help.
The design of public disclosures about executive compensation plans is surely among the corporate secretary and governance team’s most critical tasks. The board’s compensation committee ultimately designs the executive pay package, but the work that goes into it entails a collaborative process between the corporate secretary or general counsel, the company’s human resources manager, the external pay consultant and often the chief financial officer.
When corporate secretaries’ role in the compensation determination process is significant, Aalap Shah, Vice President, Pearl Meyer & Partners sees room for some improvement in how they collaborate. He suggests the pay consultant be involved in determining the compensation committee’s agenda for the upcoming year. ‘The consultant brings to the table pressing issues going on in the marketplace and industry,' he says. Combining that external knowledge with an awareness of the internal governance issues the corporate secretary must consider makes the compensation planning process run more smoothly.
When working with the HR department, ‘you’re really trying to understand the prevailing human capital issues and concerns that need to be addressed’ in any compensation plan, says Shah. He recommends the corporate secretary and HR chief ensure there is an open dialogue about what information will be provided prior to each compensation committee meeting. It’s also helpful to include HR in discussions of the company’s financial performance, so the HR manager has a better understanding of any potential headwinds in the coming year that need to be reflected in the executive pay plan, Shah adds.
It has also become more common for companies to involve pay consultants in their shareholder engagement efforts, especially when the engagement is meaningful and touches on compensation, says Shah. ‘When we speak with boards of directors and internal executive management staff, we’re hearing that there is a need to do more engagement, so I would imagine that we’re going to continue to be involved for the long term,’ he says.
January 12, 2015
ISS Offers Guidance on Equity Plan Approach
Boards are being advised to assess how their equity plans stack up against ISS’s new approach to evaluating them, but some consultants have said the latest document does not provide enough clarification. In December, ISS released its FAQs on the new scorecard approach, which will come into effect for meetings on or after February 1, 2015. The scorecard puts aside pass/fail tests and will consider a range of positive and negative factors. It will still result in negative recommendations for plan proposals that have, in ISS’s words, “egregious characteristics (such as authority to re-price stock options without shareholder approval).”
Deborah Lifshey, Managing Director at compensation consultancy Pearl Meyer & Partners, says the fact that this is no longer a pass/fail test based on plan cost is a good thing. “It is great that there are mitigating factors, if your plan has a lot of good governance and your past practices are deemed to be good governance in the eyes of ISS. It’s good to know that the plan could pass even if the plan cost is a bit more than the industry norm,” Lifshey adds.
However, the new, nuanced approach leaves gray areas for boards.
“We were hoping to have more concrete and quantifiable information so we could help our clients figure out the range scores,” Lifshey says. “But what we actually got was this very high-level, elusive document that talks about the three buckets and how things are weighted generally. And we know that we need to get a score of 53 out of a hundred, but we don’t know precise values within each question.”
She says this may force boards to purchase ISS’s model to see how their equity plans will fare.
“I think after a year of doing this we will see enough ISS feedback to better understand how certain questions are valued.”
January 8, 2015
The Rise and Rise of the CD&A
In the five years since public companies were first required to create and publish a Compensation Discussion and Analysis (CD&A), this section has quickly become the rock star of disclosure documents. While some public companies continue to struggle with how to craft a meaningful CD&A, this disclosure section has improved dramatically in a relatively short period of time.
Sharon Podstupka, Vice President, Pearl Meyer & Partners, notes that while the best CD&As typically come from Fortune 100 companies, others are making vast improvements, too. ‘The challenge of say on pay, starting back in 2010, pushed many companies to think creatively about their CD&As,’ Podstupka says. ‘And the laser focus on executive pay has become so hot over the last two years that it’s made the CD&A a source of interest not just for investors but also for the media and the public at large.’
Almost everyone concurs that while design is important, what matters most is the message being expressed. Some design elements come down to personal preference. Podstupka, for instance, thinks ‘words are more important than the look and feel of a document, but there definitely is a link.’ In terms of design, she favors crisp headers and content that flows appropriately.
While some companies have upped their CD&A game in response to an approaching say-on-pay vote, many are trying to improve simply because they don’t want to lag behind their peers.
Podstupka points out that the CD&A will need to continue to evolve once rules about CEO-to-median-employee pay ratio disclosures are finalized. She believes these new rules will compel companies to tell their stories in even more individualized ways. ‘Soon, having a boilerplate CD&A might be a practice of the past,’ Podstupka concludes. ‘And I think that’s a very good thing.’
January 5, 2015
Comp Committees Gun for Better Pay Metrics
Putting metrics in place that align executives’ interests to the long-term performance of the business and shareholder value is an increasing priority. The influence of shareholder activism and ISS’s new scorecard approach to equity plans is expected to be a hot topic in this year’s proxy season.
In a recent NACD webcast on aligning compensation with strategy, Steven Van Putten, managing director at Pearl Meyer & Partners and head of the firm’s Boston office, said that compensation programs have to evolve to meet the ever-changing external environment and business strategy. Van Putten said that if a compensation program does not evolve to meet the business strategy, it may undermine strategy because incentives may be in place that could encourage outcomes, behaviors and actions that are inconsistent with the business strategy.
Van Putten adds that companies that have good pay-strategy alignment use a balance of financial result metrics, such as total shareholder return, and metrics that take into account strategic drivers in the business, such as innovation and customer satisfaction.
November 24, 2014
Compliance and Communication Needed In Compensation Disclosure, Speakers Say
A good CD&A should “strike the perfect balance between compliance and communication,” according to panelists from Pearl Meyer & Partners who spoke Nov. 18 at the National Association of Corporate Directors webinar Compliance & Communication: The Dynamic Duo of Disclosure.
Compensation disclosure is a “constantly evolving topic,” partly driven by a change from “an audience of largely regulators looking at these proxies, to an audience of investors, shareholders and the media,” said Deborah Lifshey, a Managing Director at Pearl Meyer & Partners.
The various audiences for disclosure affect the way CD&As are drafted. Say-on-pay results “send signals about the way boards are making decisions about pay,” said Sharon Podstupka, a Vice President at Pearl Meyer & Partners. This provides pressure to do a really good job developing the CD&A. Podstupka said “boilerplate language simply isn't effective anymore and takes the drafting process to a whole new level.”
Based on a study conducted by Pearl Meyer & Partners surveying 157 public companies, in 2015, 29 percent of companies surveyed plan to add a description of their shareholder engagement actions, over 35 percent of companies surveyed plan to do a better job of explaining how they arrived at their pay decisions by including some kind of alternative to the summary compensation table and 38 percent of companies surveyed plan to add graphical descriptions to enhance the understanding of their disclosures.