My Compensation Committee New Year’s Resolution List

It is a new year! Like many people, I spent some time in December coming up with my New Year’s resolutions and yes, eating healthier and getting more exercise are on my 2019 list. After presenting a recent NACD webcast on our top five compensation topics for committee meetings in 2019, I spent some of the last few moments of 2018 reflecting on all the various issues we had weathered and jotted down a few additional to-dos for my clients to consider in the New Year.

1. Be prepared for CEO Pay Ratio disclosure, round two

Overall, the CEO Pay Ratio did not get as much attention in year one as expected. This doesn’t necessarily mean it was not a big deal, and the story may not be completely written yet. In fact, I think we may see more attention in year two when we have the ability to track year-over-year changes to both the top and bottom numbers. It will be interesting to see how certain companies explain, for example, why the CEO’s pay went up 20% and the median employee pay went up only 2%. As companies will need to focus on and be prepared for CEO Pay Ratio disclosure round two in 2019 and as the proxy season approaches, my colleague Deb Lifshey compiled a list of specifics on what companies should and should not do in the second year.

In addition, we think that committees may be more involved in the process in 2019. In year one, committee members were really not involved in the CEO pay Ratio disclosure process until the end—it was more of a regulatory exercise (i.e., meet requirements, disclose how company calculated ratio, and provide the ultimate ratios). However, for 2019, the committee has an opportunity to get a little more involved in looking at how the company did relative to peers and whether it decides to explain significant changes (if any) this year.

2. Start the conversation on gender pay equity

My colleague Melissa Means wrote extensively on this topic in 2018. She noted that “historically, gender [and other diversity-based] pay parity hasn’t risen to the board level. Human Resources has been in charge internally if and when there was a concern.” And while legislation and debate surrounding gender pay parity is not new, 2018 certainly brought a renewed focus to the issue. I believe this focus will continue and grow through 2019.

If gender-based pay parity is not already on your committee’s agenda, consider it for 2019. Melissa suggests “just asking management ‘Have we looked at this yet?’ is an easy place to start.”  We also have an NACD webcast replay available that outlines why boards should be involved in this discussion, how gender pay issues are defined, and what boards and management should be doing next. It will be time well spent.

3. Re-evaluate your clawback policies

Clawback policies have been widely adopted in some form and are relatively consistent for many companies from year to year. With that said, corporate scandals, the #metoo movement, cyber-attacks, and other unexpected scenarios have prompted many companies to consider expanding their clawback provisions. In addition, Glass Lewis’ 2019 policy update provides that it will be looking for something beyond whether a company maintains a clawback that simply satisfies the minimum legal requirements of the proposed Dodd-Frank rule (i.e., only triggered by a restatement). If a company maintains only a bare-minimum clawback, the absence of more expansive recoupment tools may impact GL’s view of the overall compensation program. We recommend the committee re-evaluate the clawback policies with a new lens this year.   

4. Understand Economic Value Added (EVA)

As a basic matter, ISS defines EVA as:

In addition, ISS’ proposed policy asserts that “EVA provides a standardized view of economic performance, versus accounting results, by applying a series of uniform, rules-based adjustments to financial statement data. Those adjustments improve comparability of companies across different industries. They allow for comparisons of firms with different operating models and/or capital structures as well as companies at different points in their business cycles.” (See this page for Pearl Meyer’s November 2018 comments to ISS on proposed changes to the FPA portion of the pay-for-performance screen, including additional commentary on EVA metrics.)

While ISS will not be replacing GAAP-based accounting measures in its Financial Performance Assessment (FPA) screen with EVA metrics in 2019 (as proposed), it will display EVA measures, including EVA Spread, EVA Margin, and EVA Momentum, in ISS research reports for “informational purposes” only and on a phased-in basis over the 2019 proxy season. ISS has left open the possibility of shifting from FPA to EVA measures for 2020 and it plans to publish additional educational materials in support of EVA metrics.

We wanted to understand what boards are currently thinking about EVA and in our December NACD webcast, we asked our audience how likely they were to use EVA as a metric in their incentive plans if ISS adds EVA to its FPA screen. While the majority (56.6%) were not likely, 26.5% were on the fence, 14.1% were likely, and 2.8% were extremely likely to add EVA as a metric in the incentive plans.

While boards taking action isn’t imminent, as institutional investors look to ISS for guidance on how to vote their shares, compensation committees should at least be familiar with this metric. In fact, it is probably worth spending a little more time in 2019 getting a better technical understanding of EVA, as it may come up during a meeting.

5. Avoid doing the “same old” (or at least have a rationale for why you are)

Like many New Year’s resolutions, you may not check off all of these items. Consider prioritizing this last one, which is to try and avoid doing things the same old way. Why? First, you’re not handcuffed with strict 162(m) process anymore. Second, things are changing in the world really quickly; today’s social and cultural norms are impacting businesses and may require you to do something different. Third, it’s always good to take a step back and make sure your executive and director pay programs are accomplishing what you want them to do. At a minimum, ensure there is a rationale for why you don’t make any changes, if that’s where your committee lands.