Does your compensation committee need a reset?

Is CEO pay aligned with value creation?

 

Executive pay packages can evoke no shortage of anger from the public.

Earlier this month, Swiss voters backed the “Rip-Off Initiative,” a plan to curb executive compensation by boosting shareholders’ say on pay. The upcoming law will also ban one-off bonuses that executives sometimes receive when joining or departing a company.

Switzerland’s justice minister said the majority vote was “the result of widespread unease among the population at the exorbitant remuneration of certain company bosses.” The referendum followed news last month that Daniel Vasella, the outgoing chairman of Swiss drug-maker Novartis AG, was to receive a “golden goodbye” worth roughly $78.7 million. (Novartis would later scrap the pay package, much to the relief of key shareholders.)

While few countries have imposed the same drastic measures as Switzerland, the heat is nonetheless on compensation committees—which approve and set executive pay—to follow best practices. Academic institutions are also keeping up, training our next generation of executives and directors on the rapidly changing terrain of best compensation governance practices and shareholder accountability. See the new course I developed for York University in this area, here.

So what are the top pay practices for compensation committees? You’ll find them by answering the 12 groups of questions below.

If you’re on a compensation committee (or simply on a board), ask yourself how many of the following questions you can answer “yes” to.

If you’re an investor who will have a say on pay this upcoming proxy season, ask yourself if the compensation committees at your investee companies conform to the practices below. The more questions that can be answered “yes,” the greater the likelihood there will be pay for performance that is directly aligned with value creation for you as a shareholder.

1. Does each compensation committee member fully understand the company’s business model, the key value drivers, and the performance metrics arising from achieving the company’s strategy?

2. Does the compensation committee precisely calibrate these metrics such that there is a direct line of sight and sufficient stretch for short-term bonuses and long-term performance-based equity?

3. Has the committee or an expert third party (independent of management) benchmarked your compensation committee charter to best practices?

4. Have you approved, and can you defend, the compensation of oversight functions (e.g., internal audit, risk, compliance) and key risk-takers within the organization? (Assume compliance failure occurs and these pay practices receive expert scrutiny.)

5. After a diligent check into committee member backgrounds, would a third party conclude that all members are fully independent? (There are several red flags that may not be captured by formal independence standards, such as prolonged tenure, interlocks, reciprocity and social relatedness.)

6. Do you have one female non-CEO on your compensation committee? Do you disclose the competencies and skills for each committee member on your website?

7. If you use an outside advisor (e.g., a compensation consultant, or lawyer to advise, negotiate or draft compensation agreements), has that person or entire firm never done work for the management before? Would he or she (or it) be objectively seen as fully independent?

8. Do you have bonus deferral, equity vesting and hold requirements that are performance-based and risk-adjusted by the committee?

9. Would your compensation disclosure satisfy an investor as being fully transparent, understandable, and absent of obfuscation or gaming? Do all committee members fully review the disclosure, or have an independent adviser do so under the committee’s direction?

10. Does each committee member issue a cheque from their own savings to satisfy stock ownership requirements? (In other words, the stock is not given in lieu of board service—they must pay for it.)

11. Does your compensation committee meet directly with key investors to hear their views, without management in the room? Whenever CEO compensation is discussed in the Committee or Boardroom, does the CEO leave the room?

12. Are pay practices and key contractual provisions, such as a “clawback” or “malus,” incorporating best practices?

If you answered yes to all questions, or even most of them, you likely have a truly outstanding compensation committee. You may even wish to apply for a governance award, here.

If you cannot answer yes to the majority of these questions, you have work to do.

Join me in my next blog post, where I will ask if your nominating and governance committee needs a reset.

Richard Leblanc is a lawyer, corporate governance academic, speaker and independent advisor to leading Canadian and international boards of directors. He can be reached at rwleblanc@gmail.com.

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