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Who is Responsible for Risk? Risk Management Has Climbed to the Top of the Boardroom Priority List.
Since 2009, regulators in the United States, the United Kingdom and Europe have brought in new rules to curb excessive remuneration in financial services and avoid situations where executives are incentivized to make short-term decisions in pursuit of a bonus.
“In financial services there used to be a blank canvas as to how much you could pay someone, but the regulatory framework has changed and mechanisms are now in place to defer and constrain remuneration,” says Simon Patterson, Managing Director at Pearl Meyer & Partners.
Too much focus on restraining executive pay can also introduce a whole new set of risks. “It does not help any stakeholder if a company is uncompetitive and misses out on recruiting the best people. There needs to be a trade-off between being whiter than white and remaining competitive,” Patterson says, arguing that looking at headline pay alone is unhelpful. Companies and investors should instead focus on how much value executives are delivering for shareholders relative to their remuneration.
Patterson believes that focusing too much on what others are doing rather than a business’s own specific needs can be the root cause of ineffective risk management: “Setting your remuneration and risk strategy against what another company is doing is like trying to drive a car from the passenger seat,” he says.
Surveys Find Higher Pay, More Cash for CEOs
Compensation rose again for chief executive officers at the highest rate in four years and reached new heights, according to several studies. The trend has been to link executive pay to performance and, in May, the SEC proposed rules that mandate specific proxy statement disclosures on the link between pay and performance. Among other things, it proposes that pay will be reported separately for the CEO and include performance of the company’s cumulative total shareholder return and peer TSR.
Many companies use TSR as a metric, but relative TSR is not ideal, according to Peter A. Lupo, Managing Director and Head of the New York office of Pearl Meyer & Partners. ‘‘TSR is a measure of performance over a very long time. There are many instances where TSR is misleading or lacking,’’ he said.
Peer groups are another thorny issue, according to Lupo. ‘‘In theory, it makes perfect sense. In reality, it works well when you have peers with similar operating models,’’ Lupo said. However, few companies have 10 to 20 similar peers, which can create false results, he said.
Report on Salary Surveys
Long-term incentives for executives have evolved into effectively mid-term incentives, reducing the overall focus of executives on the long-term success of companies, compensation specialists said May 19 at WorldatWork’s 2015 Total Rewards Conference in Minneapolis. When it comes to executive pay, compensation professionals should forget about the norm and instead focus on what is best for the company’s overall strategy.
Businesses tend to keep to the middle of what is considered acceptable by constructing executive pay packages that are similar to others for fear of criticism from shareholders, said David N. Swinford, President and Chief Executive Officer of Pearl Meyer & Partners. Sticking to a traditional executive pay plan may not be best for every company and could hinder success, Swinford said. Instead, companies should ‘‘dare to be different’’ and examine what is critical for the business, what type of person they need to succeed and how to pay that executive, Swinford added.
Boston Business Journal
June 26, 2015
The Nine Highest-Paid Life Science Executives in 2015
The state’s life science firms have a heavy representation on this year’s list of the highest-paid executives. While that’s not new, the presence of so many biotech firms and medical device firms on that list this year is a change from recent years.
Much of the reason, according to Susan Stemper, Managing Director at compensation consulting firm Pearl Meyer & Partners, is the fast-rising value of equity awards used to incentivize executives in the field of drug discovery - as the value of stock in biotech firms has risen, so too has the value of those awards.
June 11, 2015
Biotech Boom Cranks Out Some of the Highest-Paid CEOs in America
The value of biotech executives’ compensation can rise and fall with clinical trial results, approvals from government agencies and bids from larger competitors. Management teams are usually terminated after biotech takeovers, and executives know they might be “selling themselves out of a job,” said Susan Stemper, Managing Director at Pearl Meyer & Partners. Termination following a change in control typically allows for executives to cash in their equity awards.
“It’s not so much about buying the talent,” Stemper said. “It’s about buying the programs, the products and the molecules.”
Risks in pipeline, plus share price volatility are important considerations in biotech executive compensation design. Share prices can experience big swings as investors with “imperfect” knowledge bet on biotechnology companies, Stemper said.
“It’s hero one day, goat the next,” Stemper said. “Some great news on pipeline possibility, the market goes wild and you’re trading at $300 a share. Suddenly, some not so great news coming out of trial, and the price drops remarkably.”
Treasury & Risk
June 11, 2015
Preparing to Disclose Pay for Performance
The Securities and Exchange Commission has proposed rules to implement the Dodd-Frank Act’s requirement that companies disclose how the pay of their top executives compares with the company’s performance, setting off another compliance effort for public companies.
Because of say-on-pay votes and proxy advisors’ assessments of companies’ compensation packages, many companies have started to provide a discussion of the relationship between executive pay and company performance in the proxy, according to Deborah Lifshey, a Managing Director at Pearl Meyer & Partners. “It’s not in any one specific format, but over the years this discussion has blossomed and it’s really quite good for most companies.”
The SEC’s proposal would “rein in” that discussion and Lifshey is concerned that the proposed disclosure rules are “one-size-fits-all” and will make it hard for companies to show “their true pay for performance theme.”
Additionally, Lifshey notes the SEC’s use of total shareholder return in the pay for performance disclosure might lead some companies to switch to using TSR more heavily, or even exclusively, in their compensation programs, in place of other metrics. “We think TSR is an important measure and aligns short-term with returns to shareholders, but it shouldn’t be the only measure,” Lifshey said.
Pearl Meyer & Partners recommends that companies use “realizable pay”—which values equity grants at the end of the pay period, rather than the grant date—instead of the SEC’s “actual pay,” and show a three-year aggregate of all compensation along with a three-year cumulative total shareholder return, Lifshey said.
The firm has also suggested that companies be allowed to incorporate into the proposed table other metrics that they regard as important to their performance, and tag those numbers (in XBRL) just as they’re tagging total shareholder return, Lifshey said. “While you can still have the information in the supplemental disclosure, we think it can get lost there.”
June 8, 2015
How to Come Back From Say-on-Pay Failure
Failing a say-on-pay vote is relatively rare. However, if a company does receive a failed say-on-pay vote there are three main areas boards will focus on, according to Terry Newth, Managing Director at Pearl Meyer & Partners. Those are: shareholder engagement, proxy advisory engagement and identifying program changes.
“The engagement piece, both with the proxy advisors and the shareholders, is an important aspect because the whole concept of say on pay is a blunt instrument, and companies don’t necessarily understand why their programs didn’t receive support,” Newth says. “Boards would identify any concerns shareholders or proxy advisors have with their pay programs, and then discuss those as a committee, or perhaps broader than that, and understand whether those are compelling enough to make changes to the program.”
After such changes have been made, the company usually revamps its disclosure to ensure that shareholders understand how the board addressed the concerns. Sharon Podstupka, Principal at Pearl Meyer, says there usually is a recognition that something has to change in how the story is told.
“As we have seen the narrative evolve, especially with those that have a challenging vote result, the expectation from proxy advisors and the institutional investors is that it is easy to find and clear to understand what the outreach efforts look like, and how companies are responding to feedback. It is not about what they heard and how they responded to changes, but what they heard and if they didn’t make changes, the rationale for why,” Podstupka says.
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.