What should compensation committees consider when determining executive compensation? The answer, according to an expert panel convened by the National Association of Corporate Directors in Boston on November 10th, seems to be: just about everything.
It is axiomatic that compensation must be aligned to advance corporate strategy. This means that compensation committees are getting more deeply involved in understanding corporate strategy, so that they may align executive compensation to advance strategic goals.
What about pressure from ISS and activist shareholders for current earnings? The answer is, you can’t run scared. You have to do the best you can, yet not end up with something that is outlandish. Further, you have to explain what you are doing, to your shareholders, so they are not confused.
What about metrics? Over 50% of public companies now look at TSR (“Total Shareholder Return”) as a factor in fixing long-term incentive compensation. This is backwards looking; there was discussion as to whether TSR is inappropriate, and how it might interact, or conflict with, new SEC proposals for regulations linking pay to performance.
The panel also noted that companies like to relate their long-term compensation to their peer group, but with companies flopping over into different businesses, it is harder and harder to find real peers for purposes of compensation. Additionally, there is a conundrum in defining “long term” as opposed to “short term” goals; 70% of companies in one study indicated that their idea of “long term” involved only a three to five year time frame.
The biggest takeaway is that, in conjunction with fixing a combination of short-term and long-term compensation, it is necessary to both start with the company’s strategic goals and then make sure that the compensation of the C-suite and the next important tier of management both are compensated under the same philosophy so that all of the management team is pulling in the same direction.
A second important takeaway: companies cannot be complacent by de-emphasizing long-term and even mid-term strategy, as even prosaic companies with established businesses, products and client bases are changing rapidly in the current environment. Strategic planning for the long term is essential for virtually every business, and boards ignore this reality at their peril. This creates tension between the investments necessary for long-term sustainability, on the one hand, and marketplace pressure for immediate yield on the other.
Finally, and not discussed: if boards and therefore compensation committees owe a duty to their shareholders (as opposed to the company as an entity), why do not boards start with a detailed analysis of the demographics of their shareholder base to see what their strategy ought to be? That is different from listening to shareholders who reach out to you, and different from recognizing that ETFs and index funds now control the majority of investment in American companies. This has to do with defining the first step: what in fact is the cohort in your particular company to which you owe your fiduciary duty? If a majority of your investors are, in a given case, short or mid-term, don’t you have an obligation to have a strategy, and a compensation plan, that focuses on immediate returns (as opposed to what otherwise might be defined as long-term strategy)?