Executive compensation: A top 10 list for committees

Times are changing. If you want to get ahead of the curve, here are the key areas worth examining.

 
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Executive compensation continues to be in the headlines. Following the Occupy movement—which triggered an increased interest in wealth disparity—more regulations are emerging. Like potentially binding say on pay by shareholders. Or better diversification on committees and boards. If you want to get ahead of the curve, here are 10 key areas worth examining.

1. Members should be more independent

Committee independence should exceed black-letter requirements. In other words, members should be seen as independent from the outside, and assessed anonymously by fellow directors from the inside. Interlocks, prolonged tenure, personal relations, service provider associations, perks and subtle conflicts should all be addressed.

2. Define expertise and diversify

Compensation literacy, expertise and industry knowledge should be defined and met by members. The committee should not be homogenous. At least one member should be a woman. Non-CEOs and first-time directors should also sit on the committee.

3. Advisors can’t be conflicted

The committee should have access to non-conflicted advisors. If an advisor’s colleague seeks to do, or has done, work for the company, that advisor should not be retained. The consulting industry has not done an adequate job addressing conflicts and professional standards. Further regulation is coming. There should be no undue funneling by management in advisor retention.

4. Incorporate risk-adjusted metrics

Compensation consultants, if used, should be instructed by the committee to incorporate risk-adjustment metrics. The committee should understand how to do this. If they don’t, they should get independent advice.

5. You need proper clawbacks and malus

If these clauses cannot be drafted by the committee itself, they should not be drafted by management or internal or external counsel (who are conflicted by being self-interested), but by an independent advisor consistent with best practice and industry standards.

6. Link pay to performance

Management prefers short-term, quantitative and formulaic pay plans. Regulators explicitly want compensation committees now to incorporate qualitative, longer-term metrics, pay periods and discretion. More rules are forthcoming, but compensation committees need to be able to understand the business model, the key strategic drivers and how to get this right so that pay equals performance. This often doesn’t happen. Re-cutting pay plans is emotional and adverse; compensation committees need courage and resources at least equal to that of management.

7. Ensure meaningful shareholder engagement

The committee should meet directly with key shareholders without management present on a regular basis. Binding votes on pay are forthcoming. Conflicts of interest among institutional investors and asset managers and other barriers to engagement will likely be addressed. Boards should prepare for direct shareholder engagement and voting on boards in the future—we have the technology.

8. Revaluate pay equity and disparity

The use of peer groups (vs. CEO rankings) at the 50th, 75th or 90th percentile have resulted in a perpetual compounded 17% increase in overall CEO pay. This increase results in a significant disparity not only in the C-suite, but also with the average worker. When ratios emerge, committees should scrutinize and act appropriately. This disparity is part of public and regulatory parlance now. Inaction is resulting in regulation.

9. Think beyond the CEO

Boards increasingly should want to see a deep talent bench for key units and functions, beyond the CEO. CEOs resist, including in their own succession, but boards should persist. Succession should be part of the pay package for intransigent CEOs. Proper CEO succession mitigates excessive executive compensation payouts.

10. Director pay

Lastly, management has an interest in paying directors beyond what is required for a part-time job, including for non-executive chairs. Committees need to push back on exorbitant pay that can be reasonably seen to compromise their own independence. In the U.S., for example, the NACD had recommended a 15-16% premium for lead directors, specifically to guard against the compromising of independence.

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