Structure for executive compensation may need overhaul
Compensation committees have good reason to seek expert advice. The personal reputations of directors are at stake due to a more complex and demanding environment. There is much more regulation, media scrutiny is increasingly intense and shareholders are better organized and more vocal than ever.
Business is brisk for executive compensation consultants who spend hours briefing committee members on trends, regulatory requirements and good governance guidelines related to executive and director compensation.
At issue is whether the current structure enables compensation committees to meet the increasing demands placed on them or whether it’s time to consider new criteria for membership.
Role and responsibilities
A compensation committee is a committee of the board of directors, usually consisting of independent directors (who are not part of management). The committee has a written mandate that typically entails:
• setting the performance goals and assessing the performance of the CEO and overseeing the CEO’s role in doing the same for other officers of the company
• reviewing and approving the compensation programs for the officers
• reviewing and approving the goals for incentive programs and long-term incentive grants
• overseeing public disclosure related to executive compensation.
The compensation committee also frequently has the responsibility of overseeing the succession planning process and, occasionally, director compensation.
The CEO and often the CFO or vice-president of HR attend compensation committee meetings but do not have voting privileges. While the chair of the compensation committee sets and manages the agenda, management almost always brings forward the materials for review and approval of the committee.
Better-organized committees have a work plan that sets out the activities and outcomes for meetings over a 12- to 18-month period.
Committees carry out their duties during four to eight meetings per year. Meetings typically last two to four hours.
Committee members often have many business skills but their compensation knowledge is typically limited to their personal experiences as executives. And that information is often dated or narrow.
As a result, the decision processes and skill sets of compensation committees are frequently not keeping up with the demands on the committee. In fact, directors often express concern about remaining on a committee or expect more compensation for doing so.
Increasing complexity of compensation package
When executive compensation consisted of a salary, a discretionary bonus and a stock option grant, none of which was too excessive and all of which was decided behind closed doors, life was simple.
Over time, the principle of pay for performance rightfully became the dominant objective for many pieces of the compensation package. The complex nature of businesses has resulted in equally complex programs to adequately measure and reward performance across the business and across time horizons.
Comparing the quantum of compensation among various companies is also complex, as are the tax and accounting implications for programs.
On behalf of shareholders, regulators of publicly traded companies require greater transparency regarding compensation decisions and the decision-making process. Discretionary decision-making is discouraged. Committees need solid data and methodology to justify their decisions, which are subject to public scrutiny and often to media coverage.
Advocacy groups turning up the pressure
The nature of executive and director compensation and, consequently, the demands on the compensation committee, are being shaped by shareholder advisors. Organizations such as RiskMetrics Group (RMG) and the Canadian Coalition for Good Governance (CCGG) have recently found new power.
Institutional investors are feeling increased pressure to conduct thorough due diligence in voting their shares, so they will hire RMG to recommend voting positions on resolutions requiring shareholder votes. Companies are bringing practices into alignment with RMG’s voting guidelines to ensure resolutions are successful.
The CCGG represents more than 40 institutional investors and sets policy pertaining to executive compensation, among other things. Recently, the CCGG developed very extensive guidelines.
It also has a board engagement policy whereby it meets with the chairs of a board and compensation committee to review a company’s compliance with the guidelines.
This process has encouraged many major companies to review programs and processes to ensure greater compliance with the CCGG’s guidelines. Improved governance is a highly desirable outcome but it also dramatically increases the need for both greater expertise and time commitments on the part of compensation committee members.
It seems quite clear the structure for executive compensation governance via the traditional compensation committee is running into difficulty meeting the demands of the role. It may be time to examine the expectations and devise a new format that is more capable of meeting those expectations.
Just as audit committees are staffed with chartered accountants, perhaps compensation committees need to be composed of compensation experts who are expected to work beyond four to eight meetings per year. These professionals can enhance executive compensation governance through better processes, interpretation of data and technical expertise.
Chris Howe is a senior executive compensation consultant at Hewitt Associates in Toronto. He can be reached at [email protected].
