July 19, 2018 Executive Compensation Executive & Director Pay Design Articles

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Executive & Director Pay Design

What to Expect From Your Pay Consultant

Consultants don’t provide their most valuable service in the form of answers to tough questions. They do so by posing the tough questions in the first place. While compensation committees need answers about compensation data and pay program design, they will get more value by expecting their consultants to act as thought partners.

A productive advisory relationship develops when consultants and directors treat compensation as a management tool. Directors should expect consultants to understand corporate strategy, identify performance measures and designs to support that strategy, know how those designs may conflict or align with shareholder needs, and fashion a pay program that navigates the differences. Here are the top five questions consultants should lead directors to explore.

What Should the Pay Plan Accomplish?

A plan that doesn’t motivate executives to work differently is a plan stuck in neutral. A plan that drives executives to distinctive outcomes is one in high gear. A good pay advisor will help you choose measures, weightings, and vehicles deliberately.

A building products company, for example, had a standard pay program featuring sales and earnings growth as measures. The problem was that even with good results on both counts, the stock was not rising. The board’s pay advisor pointed to weak returns on capital. Meetings with investors confirmed that their biggest concern was that returns didn’t exceed the cost of capital. To ensure growth that created shareholder value, the board approved a new pay component that paid out only with higher returns.

A retailer also had a program measuring sales and earnings. In contrast, however, the worry was that as executives built outlet stores” for which they were paid well in restricted stock and options” margins declined even as sales and earnings grew. Although the plan stimulated growth, it was the wrong kind. It also diluted the brand. The advisor’s analysis of the opportunity to better align the pay program with stated strategic priorities helped spur deep conversation with the board and management. A new program aimed at increasing growth in global sales, average daily transaction value, and luxury store openings improved margins and spurred a restoration of the brand to its luxury-store roots.

Consider how the plan drives individual or team accountability, what the current circumstances require, and how the pay plan design can help drive alignment between these two elements. An auto manufacturer, for example, had a long-standing strategy that challenged each region to operate and perform independently. For a time, the individualized approach made sense: the Asia-Pacific region focused on growth and market share, while the North America region focused on quality, cost containment, and cash flow.

But as supply chains became more integrated, and as product innovation priorities converged, the consultant began discussions with management noting that executives working together would boost company fortunes faster than working for their region alone. The company shifted the weighting of its pay plan measures to stress global metrics. That helped validate a new culture and the best path to value creation. As the experience of each of these companies shows, just as company strategies for creating value change, so should compensation programs. Pay advisors can help raise the right questions at the right times, allowing directors to get the most from their consulting relationship.

Where Are the Land Mines?

Your pay program may have unintended consequences, such as sending ill-advised signals, creating inappropriate payouts, and other land mines that an outside advisor could spotlight.

A retailer with aggressive growth aspirations wanted to weight comparable-store sales heavily in its pay program. Conversations with their consultant highlighted that the measure, though commonplace, risked motivating executives to do the wrong thing: boost total sales while hurting profitability by maintaining unprofitable stores, pursuing excessive promotion, and giving away inventory. How could the company avoid the consequence of overzealous” and unprofitable” growth? The company added an overall margin measure in comparable store sales. That adjustment motivated executives to expand briskly, but only so long as they grew profitably.

A high-end apparel maker had a pay program that stressed aggressive earnings growth. The pay advisor, however, identified a problem: more than half of the incremental growth was paid out to executives. This was a land mine buried in an otherwise sensible program. Shareholders would think the payouts unreasonable, and the company could anticipate proxy season criticism. The company reworked its plan to create fairer sharing of gains. Such cases point to the need for directors.

View the full article as it was originally published.

Roger Brossy

Blair Jones

This article was originally published in NACD/Directorship.

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