When it comes to executive-pay strategy, boards of directors need to put the spotlight back on building great leadership teams to drive their companies’ long-term success, according to a recent white paper from compensation consultancy Pearl Meyer & Partners.
“In today’s economic and governance environment it is essential that companies go beyond best practices, beyond data, beyond check-the-box compliance and beyond the obvious,” said David N. Swinford, the firm’s president and CEO.
In recent years directors have increasingly been focused on satisfying proxy advisory pay standards and compliance requirements, driving many companies to “conform to the norm,” Swinford noted. The result is copycat pay programs that are based on current pay trends, peer practices and competitive data.
“Simply following the crowd ignores the huge impact that a differentiated compensation strategy can have on building a strong management team that’s focused on that company’s business strategy,” added Swinford. “An effective executive-pay program should send a strong signal to employees and to the marketplace about that company’s goals, priorities and vision.”
In The 2013 Compensation Committee Agenda: Go Beyond, Pearl Meyer &Partners outlines five approaches to help directors ensure that executive-compensation programs—including the use of performance-based incentives—will drive the strategic priorities. The five key ways to support a complex set of strategic needs are:
- Buck trends and best practices in favor of business-based plans. The committee’s goal is to build a great company, and if it performs, then say-on-pay votes will take care of themselves. "Every company should conduct an annual communication program around executive compensation with its largest shareholders," the report states. "Resist the temptation to dwell on the shortcomings of proxy advisory firms, and focus on listening and responding directly to the concerns expressed by shareholders."
- Link realizable pay to compensation decision-making. Considering the actual level of pay relative to the company’s actual performance gives committees real, actionable information. "Realizable pay relies on the value of equity awards based on actual company performance, rather than simply the grant date accounting value—which makes it a far more relevant number for analyzing the pay-to-performance linkage," the report advises. "However, rather than being relegated to the appendix of a once-a-year report to the committee, a realizable pay analysis should be referenced at key points throughout the annual compensation planning cycle to help assess and promote pay-for-performance alignment."
- Spend more time on the performance side of the equation. It’s not just the level of pay—companies have to get both sides right. "Many companies give too little consideration to picking the right incentive measures and periods for their specific company, setting challenging but reasonable performance goals, and then calibrating awards for every level of performance," according to the report. "It may take more upfront time to creatively apply analytical tools in making such decisions, but the payoff in better plan design is generally well worth the effort."
- Apply a new lens to equity plan design and award values. The choice of long-term incentives and the size of payouts should be based on performance and retention strategies. "Most companies grant annual equity awards using a target multiple of salary or dollar value that is approximately equal to market median pay data," the report notes. However, "starting with a target dollar value has a counterintuitive result, since executives receive fewer options/shares in the wake of strong stock performance and more options/shares as the stock price declines." One response: "Proactively manage the existing target value approach. For example, hold the target value steady for more than one year and/or de-couple the target from annual base salary increases."
- Customize your risk/reward profile to the business. Compensation plans should evolve to reflect the business risks and HR needs of companies at different life-cycle stages. "Rather than relying on prevalence-based pay designs, companies need to be willing to consider atypical pay programs that will attract and motivate the talent needed to execute the business strategy. Once the HR priorities are identified, the compensation strategy can be designed to support those priorities."
Related SHRM Articles:
Linking Executive Pay to Performance, HR Magazine, September 2013
Employers Don't Expect to Fully Fund Annual Bonuses, SHRM Online Compensation, August 2013
Apply Long-Term Incentive Plans at Private Firms, SHRM Online Compensation, August 2013
Reviewing Executive Compensation at Not-for-Profits, SHRM Online Compensation, June 2013
Designing and Managing Incentive Compensation Programs, SHRM Toolkits, June 2013
Designing Executive Compensation Plans, SHRM Toolkits, December 2011
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