April 11, 2018 Executive Compensation Executive & Director Pay Design Articles

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Executive & Director Pay Design

Orientation to Match a New Reality

For years, compensation committees have focused on overseeing pay practices, designs and levels for an organizations’ top executives. Now, out of necessity, that charter is being expanded.

On the one hand, shareholders are demanding broader conversation. Say on pay has worked as intended to create more dialogue between companies and investors, and those discussions are increasingly involving compensation committee members. Not surprisingly, committee members are finding shareholders don’t want to talk about pay in isolation: pay is a litmus test for broader governance issues and an entrée into discussions of other governance matters of interest. For example, if you were to ask which director should field a request by shareholders to expand board diversity or address climate change concerns, whom would you choose? You might assume the lead director or the chair of the governance and nominating committee. But if the request came through a say on pay engagement, you might not get that choice. The question could be raised first to the compensation committee chair.

New committee members need to gain sufficient understanding of compensation practices deeper in the organization to understand where business risks might lie.

In concert, new regulatory requirements, investor attention to social issues, and continued focus on management succession planning are placing a spotlight on pay practices deeper in the organization as well as diversity and inclusion and talent development initiatives. The CEO pay ratio” and in the UK, gender pay equity” focus directly on broader pay practices. Likewise, requirements to conduct annual compensation risk reviews and implement clawback policies require a familiarity with broader based pay designs and controls. Social issues such as sexual harassment, the opioid crisis and social media’s impact on children require new board awareness and sensitivity to how pay decisions are evaluated within that larger context and may even lead to new compensation measures.

While today, only about 20 percent of S&P 100 compensation committees include a reference to talent development or people in their formal committee names, it doesn’t really matter. The broader directive is there, title or not.

As the demands on compensation committees change and as expectations ramp up, what new skills and knowledge do members need? What sort of onboarding should they get? And what should be included in the table of contents of their onboarding binder? More than ever, onboarding for compensation committee members needs to anticipate new levels of engagement on shareholder priorities, broader-based pay philosophy, and talent issues.

New compensation committee member orientation materials will still need the basics. For example:

  • The committee calendar, agendas and charter
  • The compensation peer group and recent compensation benchmarking
  • Summaries of existing executive compensation plans, their mechanics, history and supporting rationale (i.e., why are these plans are right for the company at this point in its history?)

However, the emerging committee mandate requires additional context.
How are proxy advisors and shareholders evaluating the executive compensation program? More importantly, what environmental, social and governance (ESG) and business issues might they be integrating when they review compensation? What work from other committees or the board might bleed into the executive compensation conversation?

New committee members will also need to gain sufficient understanding of compensation practices deeper in the organization to understand where business risks might lie. What measures are used in the different incentive plans, and how do the mechanics work? What could go wrong? What unintended behaviors could be encouraged? What is the company’s compensation philosophy for broader based pay?

This understanding will help them better appreciate how the median employee’s pay was determined, as well as inputs that may influence gender pay equity. What are the relevant company policies related to talent and pay? How are any outliers being addressed? From a succession-planning standpoint, what programs and support exist for leadership development? How is the company progressing on diversity and inclusion? How does the company ensure that the diversity and inclusion initiatives not only look good on paper, but are also visible, particularly in the leadership ranks?

Compensation committees aren’t just for executive compensation oversight anymore. Newly emerging expectations are expanding compensation committees’ oversight, taking committees into previously unchartered territory. If you’re in charge of onboarding directors to the compensation committee today, it’s important to acknowledge the momentum in the current environment to best equip them for today’s larger mandate.

To see the published article, download the PDF or view the magazine online.

View the full article as it was originally published.

Blair Jones

This article was originally published in Corporate Board Member.

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