Having their say

A new voice joins the vigorous compensation debate amongst proxy advisory services, shareholder activists and corporations in the form of the HR Policy Association’s Center on Executive Compensation. With CEOs being chastised for exorbitant pay – a US congressional panel recently grilled CEOs who garnered high payouts, including Merrill Lynch’s Stanley O’Neal ($161.5 million), Citigroup’s Charles Prince ($39.5 million in stock, options, bonus and perks) and Countrywide Financial’s Angelo Mozilo ($121.5 million in options and $22.1 million in compensation) – an invigorated response from the corporate side is no surprise.

The vice chairman of the Center, Richard Floersch, previously headed up the HR Policy Association’s executive compensation subgroup, which led to the creation of this new entity meant to generate strong principles using feedback from HR Policy’s 250 member companies. Formed in April 2008, the Center opines on SEC and IFRS regulatory proposals, lobbies Congress on compensation issues and circulates surveys so that companies can learn from one another. Floersch describes a solution-based approach that aims to ‘provide strong examples where executive compensation is working, develop suggestions for improvement and be a practical voice around what might work better within companies with respect to regulations and other public policy developments.’ Vice president for policy Charles Tharp indicates that research will focus on ‘a pay-for-results methodology’ for equity compensation, elucidating how to value ‘different plans so you can have an apples-to-apples comparison, so that when people are doing comparisons it will be in an informed way.’

The Center currently boasts a membership of 36 corporations, but as observed by Tim Bartl, assistant general counsel and vice president of corporate relations at the Center, it isn’t just the corporate HR world that is supportive of the Center and its work, the critics are also receptive. ‘It appears they’re glad we’re actually intellectually engaging in the debate.’

A role of one’s own

Representing corporate views on compensation has, to this point, predominantly been the domain of Business Roundtable (BRT), which first published a concise treatise on executive compensation in 1992 followed by a rundown of best practices in 2002, and continues to work for the interests of CEOs and senior executives. Contrary to recent media reports, BRT does not see the Center as a threat. ‘We welcome it,’ asserts BRT president John Castellani, noting that the Center’s HR professionals already contribute to BRT’s coordinating initiatives. ‘Many of the CEOs for whom the HR Policy Association members work participated in drafting [BRT’s] principles and of course their job is to implement them,’ he says.

HR professionals offer important insight, he continues, as they ‘work very closely with the board’s compensation committee chairman to make sure the chairman has the information necessary so that the compensation committee can undertake a thorough review of the company’s executive compensation policies … [and] make sure compensation systems at all levels provide the right incentives for creating shareholder value.’

Castellani anticipates that BRT and the new Center will share information, both because they share a membership base and because they agree on many issues, including transparency, tying compensation to results and having compensation committees made up of independent directors. He also points out the important differences between ‘those who set the strategy and the vision and those who are actually charged with the implementation.’ The opportunity to learn from each side will also improve the overall discourse on executive compensation.

Proxy Governance chairman Jim Melican is skeptical about whether the HR perspective will be perceived as all that different. ‘I think it will be a little bit better but not much,’ he says. With an HR-run group, he believes, ‘it will generally be thought that at the end of the day they work for CEOs.’ Endorsing these fears, Richard Ferlauto, director of pensions and benefits for the American Federation of State, County and Municipal Employees (AFSCME), sees the Center as ‘part of the general business effort to offset greater shareowner voice on important corporate governance issues.’ He is hopeful, however, that it will generate sound information. ‘The Center takes a much more nuanced approach to the pay debate, which hopefully should be reflected in well-reasoned dialogue on pay issues rather than the political demagoguery of BRT.’

According to Bartl, it is the head of HR’s role to work in the best interests of the company, which includes the employees and the shareholders. He says the Center’s ‘fair and reasonable’ principle reflects the balance the HR function must seek when assessing whether a package is ‘fair to the company and that it’s designed to keep talent; and fair to other employees in that there is alignment with the companies position competitively and economically.’

Melican doesn’t think the Center was started to protect corporations and looks forward to more insight like that provided by BRT, which he says ‘helped to reign in the outliers in the sense of agreement on what actually constitutes best practices.’ He also hopes the Center will provoke a similar response. ‘I think if this group can do something similar in the compensation area and really get people reflecting on the turmoil in this area, [it will be a positive development].’

Making performance matter

Floersch’s experience as executive vice president, chief human resources officer at McDonald’s and his involvement with its compensation committee informs his role at the Center. At McDonald’s, ‘we have something called a Plan to Win,’ he says. ‘It’s a very clear set of business strategies and our compensation programs have a direct link to those.’ Tailoring compensation to business strategies is a core value for the Center – and a practice frequently sought by shareholders. 

McDonald’s also believes in strong pay for performance, and makes sure ‘from the standpoint of both our employees and our shareholders that people can see the direct link between what the rewards are and what the performance has been.’ Bartl affirms that this premise is equally upheld by the Center, which maintains that ‘properly designed reward programs will help reward and help drive shareholder value.’

Ferlauto welcomes these pay-for-performance goals, but insists the Center should also promote ‘long holding periods for options after exercise, rigorous performance metrics linked to long-term value creation and severe restrictions on tax gross-ups and perquisites that have nothing to do with shareholder value.’ In response, Bartl touts the Center’s principles, including stock-ownership and/or retention guidelines. ‘One of the key factors in the application of those elements,’ he says, ‘is that flexibility is necessary so that companies can implement what best fits their strategies.’

We know what you want

Ferlauto thinks some of the Center’s decisions that are ‘against the fundamental principle of giving shareowners an advisory vote on executive compensation’ contradict pro-shareholder motives.

‘Shareholders ought to have a voice on executive compensation, but not a vote,’ clarifies Bartl, due to the fact that channels of communication are already in existence. He advocates the effectiveness of letters to the corporate secretary and speaking at shareholder meetings, which can include shareholder resolutions. The Center is also exploring a wide variety of other means of communication, including increased use of ‘dedicated websites, allowing for the ability to communicate with one or more directors via email’ and conducting meetings with the largest shareholders. 

A great degree of judgment goes into compensation. ‘You can’t align pay and performance unless you’re tying very closely some of the incentive measures to the company’s ultimate objectives,’ notes Bartl. ‘Oftentimes shareholders aren’t going to have that same confidential and strategic information as management and the board,’ which, ‘if disclosed to the shareholders would put the company at a competitive disadvantage.’

Like the Center, Proxy Governance is generally opposed to ‘say on pay’, with the caveat that if a specific problem arises at a company it has in some instances recommended a favorable vote on the proposal. Melican maintains that ‘directors, given the information they are privy to, are [usually] in a better position to make that determination than shareholders who are not party to discussion concerning precisely what the corporation’s objectives are.’

‘I can’t tell you with any given vote tally what it is shareholders are voting for or against, as some shareholders have different agendas in voting against compensation that are not related to compensation,’ Bartl observes. ‘Shareholder resolutions that identify particular pay practices or pay elements that shareholders seek to change are much more effective than a general, non-specific vote on pay.’ He predicts that if Congress mandates a vote on pay, executive pay packages could become less company-specific as companies adopt ‘safe’ pay structures designed to win shareholder support, instead of tailored to business strategy. ‘In addition, shareholders, under a mandated vote, are not going to be able to keep up with the volume of votes,’ he adds, which could further increase the sway of proxy advisory services. ‘We are opposed to legislation mandating a shareholder vote on compensation for each company,’ Bartl says, due in part to the potential for a concentration in power on behalf proxy advisory services.  

A necessary voice

In the short term, Tharp says, the Center plans to examine ‘the different views of the institutional investors – especially the largest ones – on executive compensation and the effect of SEC disclosure … especially in the area of disclosure of performance targets.’

‘There are some targets that should be, and need to be, disclosed, especially those that are based on publicly available information,’ he explains. ‘However, when there are company-specific incentive targets that are used that are not otherwise disclosed and that really can cause competitive harm, we think that there should be some additional clarity around how those concepts apply in the context of executive compensation.’ Much ambiguity has surrounded the application of these concepts, which Bartl says ‘have been applied in the context of financial statements, and it’s a little different in the compensation world.’

New research is always welcome in the sphere of compensation. But, Melican says, ‘in our mind, the most important role is that of the directors sitting on the compensation committee.’ As his view percolates through the business community, we might be in for yet another voice on compensation.