Blue ribbon commission report has 10 recommendations for exec comp committees
Executive compensation may well be the most critical and challenging responsibility for boards, especially with mounting pressure from investors, the media and other observers increasingly helping to set the compensation committee’s agenda.
Nearly one third of respondents to the National Association of Corporate Directors' 2014-2015 public company governance survey say their board changed the executive compensation plans in response to pressure from investors, according to a report recently released by NACD. Almost 60 percent of respondents say their board expanded compensation explanations in the proxy statement as a result of shareholder feedback.
With several major regulations mandated under Dodd-Frank yet to be finalized, including those regarding disclosures of pay for performance and pay ratios, as well as policies concerning claw backs and hedging, scrutiny and expectations of compensation committees aren’t likely to decrease in the near future, Barbara Hackman Franklin, chair of the Blue Ribbon Commission, writes in the report.
Report of the NACD Blue Ribbon Commission on the compensation committee offers 10 recommendations -- a playbook of sorts -- for compensation committees to consider when evaluating their policies and approaches. It also addresses directors’ greater involvement in both the development and execution of the corporate strategy, including compensation.
What’s new and different this year is that NACD has recommended expanding committee oversight into talent development throughout the company, NACD president Peter Gleason said in an email. ‘So many companies are working to enhance the pipeline within the organization to strengthen it should the company need an internal CEO promotion. But they need to ensure that they have the talent behind that person to backfill a few layers down’ as part of sustainable business practices.
Among other key recommendations in the report, NACD suggests that executive compensation plans balance long-term incentives with short-term operational goals, clearly reflecting and supporting the company’s strategic plan. ‘Given the board’s focus on strategy and alignment of short-term execution goals with the long-term plan, there’s a direct tie-in to compensation for both focal points,’ says Gleason. ‘Organizations have to achieve certain things in the next year to 18 months, and they’re going to incentivize performance against those goals in addition to longer-term incentives placed on longer-term goals – but it all has to tie together. The compensation committee has to look at both the short and long-term goals to ensure they align.’
Compensation committees have a responsibility to inform and educate the full board on an ongoing basis about the link between performance and payout outcomes. ‘The challenge here is that compensation plans are unbelievably complex as you relate them back to the various performance metrics the company bases the plans on. So complex, in fact, that it takes a fair amount of education to have the entire board fully understand the payouts for the performance metrics, as well as the timing,’ he explains. With most long-term incentive plans paying out over three to five years, the board needs continuing education to ensure its members understand the payouts that may be triggered under a particular scenario during that time frame, he adds.
NACD also suggests using peer group and market data as a ‘reasonability test’ for pay plan design, but not letting it drive decisions. ‘It’s a component to the system of checks and balances,’ he says.
Another recommendation is that the compensation committee chair be prepared and ‘presentation ready’ for shareholder communications. Given how uncomfortable it can be to ask a CEO directly about his or her compensation, major investors need the option of speaking with directors, some of whom are better at communicating than others, says Gleason. It’s not necessary that the entire compensation committee attend these meetings, but the committee chair must be prepared to, and comfortable with, communicating goals and strategy tie-ins to compensation and company performance.
Gleason urges directors to study all 10 recommendations. ‘The biggest takeaway is the tie-in with pay for performance disclosure and communications because they may be positioned as two very different things. A [Compensation Discussion & Analysis section] now has 46 pages within a proxy statement, full of information about the whys and hows of compensation. Boards must approach this very carefully with a lot of thoughtfulness around how the company is disclosing information that is necessary for shareholders who need to understand the tie-in to company performance. It’s critical and it must be done in plain English.’
