Designing an executive compensation program is among the board’s core responsibilities. Typically overseen by the compensation committee (also called the remuneration committee), the goal is to develop an executive pay package that incentivizes the right behavior and moves the company towards its business goals. At first glance, compensation committee responsibilities seem straightforward; yet, today’s executive compensation arena requires a significant amount of unpacking.
“[CEO] compensation issues involve a lot of judgement,” said board member Jim Curtiss, a long-time compensation committee chair, “and everyone wants to express a view in one way or the other.”
Indeed, the 2010 Dodd-Frank Act instituted significant reform within the executive compensation process, including mandates around committee member independence, disclosure and consultant relationships. “Say on pay,” another key Dodd-Frank reform that allows shareholders to weigh in on CEO pay practices, has historically been met with high support levels across companies. Still, today’s compensation committees must continue to balance interests amid evolving tax regulations, an increased focus on ESG, and an on-going refrain that “CEO compensation is out of control.”
Increasing Compensation Committee Transparency
Throughout the last few years, we’ve seen a significant emphasis on transparency across the executive compensation landscape. Shareholders want to know how the board is approaching its compensation design–a story that the compensation committee is expected to tell in the Compensation Disclosure & Analysis (CD&A) section of the proxy statement. Investors are also pressing boards to think about how compensation decisions can impact the company’s long-term strategy for growth, whether negatively (e.g., Wells Fargo, Persimmon) or positively (e.g., talent acquisition).
Recent tax reform is another influencing factor in the compensation committee process. Last year in the U.S., the 2018 Tax Cuts and Jobs Act limited company tax deductions on certain types of executive pay; yet, it subsequently granted boards more flexibility to use discretion within their compensation structures. This use of discretion, explains Meridian Compensation Partners’ Annette Leckie, may actually be an important tool as investors press boards to align compensation with a greater company focus on ESG.
Linking pay and performance is a fundamental principle that’s not going to go away. But using discretion and linking pay for performance are not mutually exclusive concepts. In fact, using discretion can actually tighten that link up.
— Annette Leckie, Partner with Meridian Compensation Partners
The long-awaited CEO pay ratio also went into effect in 2018. This Dodd-Frank regulation required companies to begin disclosing CEO compensation in relation to the company’s median employee. While significant backlash was predicted to follow its debut, the CEO pay ratio largely flew under the radar. Still, compensation committees should continue to improve their disclosure and shareholder engagement efforts in this area.
Telling Your Compensation Story
Whether a company’s CEO compensation is high or low is always relative. Peer group selection is a critical part of the compensation committee process; proxy disclosure should (1) detail how the peer group was selected and (2) visualize where the company falls within the peer group.
Again, today’s boards must use the CD&A to tell their company’s pay story. Not only are boards expected to show the link between say on pay and pay for performance, but they’re expected to frame the compensation strategy in the context of the long-term company strategy.
The CD&A executive summary is probably the first destination for most investors. Written well, it may be their only destination.
– Ron Schneider, Director of Corporate Governance Services, Donnelley Financial Solutions
Given the nature of the topic, compensation committee members should also be prepared to engage with shareholders around CEO pay. Shareholders typically want to hear about the executive compensation strategy from the board and not the executives themselves.
Compensation consultants typically play an important role in both the compensation strategy and disclosure, as they advise on peer group selection and incentive design through the lens of investors and proxy advisors. In a recent episode, we reviewed key criteria for selecting and evaluating a compensation consultant.
The success of today’s compensation committees relies on whether they have the right data at their fingertips. Not only must they have access to the same data their investors have, but tools that enable peer group modeling can give compensation committees full visibility across their benchmarked peer companies.
Compensation Committee Data
Compensation data providers like CGLytics equip compensation committees with an advanced peer group modeling tool, which allows boards to analyze and track various aspects of their executive compensation in the same way investors and proxy advisors do. Click here to learn more about CGLytics Pay for Performance modeling tool.