Staying on top of what's new in executive pay is a challenge even for the most dedicated experts. It is particularly daunting for those broad-based HR practitioners who do not focus on executive pay regularly. But the need for a broader understanding of the key terms and concepts surrounding executive compensation has never been more acute, as compensation committees look to develop stronger connections between HR programs for the top team and for the overall employee population.
Below are 10 executive compensation issues that all HR professionals, regardless of their specialty, should understand as they plan for greater integration between the executive compensation program and broad-based HR strategy
Executive Compensation Governance
This broad term refers to the executive pay decision-making processes designed to balance diverse interests on the part of shareholders, board members, executives and Main Street. A company’s board members face unprecedented scrutiny around these decisions.
Connection to HR. Compensation governance is no longer just about pay; the compensation committee is tasked with leading succession planning processes. As a result, corporate boards are becoming more involved in the operations of leadership and talent programs.
Action item. Now is the time to prepare for the day when the board will ask for “something on how we’re developing leaders.” Prepare a summary of the key leadership development programs and identify those high potentials that are on the cusp of becoming senior management.
Legislative initiatives on executive pay seek to arm shareholders with more and better information and to give them the tools to hold boards accountable for their decisions.
Connection to HR. Institutional shareholders increasingly are advocating stronger pay-for-performance links. This has implications for broad-based compensation practitioners, as more large companies extend the rigor of their executive programs down further into the organization.
Action item. To the degree that there is misalignment between the executive and broad-based pay programs, compensation teams would be well served to identify the gaps and assess where stronger linkages make business sense.
Shareholder Advisory Groups
Advisory groups often take formula-driven approaches to assessing executive pay programs, and some shareholders vote in lock-step with their recommendations. As a result, it has become a prerequisite for every compensation committee to know how advisory groups feel about an issue before making a decision on it.
Connection to HR. One of the hot-button issues for advisory groups relates to how companies use their authorized shares for employee stock grants, which can dilute shareholder value. This puts significant pressure on a company’s broad-based equity grant program. As a result, long-term incentive (LTI) eligibility is becoming increasingly restricted, which can make retaining key mid-level talent difficult.
Action item. Review equity grants carefully to ensure that shares are going to the right places. Look for ways to reduce overall share consumption while making sure that key high-potential talent continues to receive meaningful grants.
Say on Pay
Say-on-pay provisions in the recently-passed financial reform law give shareholders a nonbinding vote on executive compensation. Rest assured that no director serving on a company board wants to have his or her pay decisions voted down, advisory or not.
Connection to HR. Say on pay will prompt several changes to executive pay programs, some of which will cascade down the organization. When they do, the HR team will be responsible for communicating those changes.
Action item. Watch for greater pressure to cascade the pay for performance structures in place for executives down throughout the broad-based compensation program. Get ahead of that now to understand where the “holes” in the broad-based program may be.
In light of stepped-up oversight under financial regulatory reform, boards and compensation committees no longer can afford to retain executive pay consultants that earn significant streams of revenue doing other work for the company, giving the appearance of a conflict of interest.
Connection to HR. Consulting relationships might run deep in an organization, and if the consulting firm is providing executive pay services to the board, something will have to give.
Action item. Take stock of the company's consulting relationships and engage in a process that determines where a consultant does the most good, whether it be in executive pay, benefits, broad-based compensation or leadership and talent services. In the meantime, dust off that request for proposal.
This provision may be the one that has the greatest impact on broad-based HR practitioners. Securities and Exchange Commission (SEC) rules issued in December 2009 require companies to disclose if any of their compensation programs could cause employees to engage in behavior that is “reasonably likely to have a material adverse effect on the company.”
Connection to HR. This provision applies to reward programs, requiring HR teams to inventory and assess the risk profile of every material incentive program throughout the organization. While a multi-departmental team of legal, risk management and finance is typically involved, it should be HR’s ball to carry.
Action item. If the company has yet to conduct a compensation risk assessment, or if the review was conducted without the broad-based compensation team, then HR is behind in the game. The HR team should be front and center in this process.
The trend in the past several years has been for companies to transition a greater proportion of their executive LTI awards to performance-vested share plans. Unlike stock options or restricted stock plans, these programs typically vest in accordance with three-year company-wide performance and might not vest at all.
Connection to HR. As executive and broad-based plans become more aligned, performance equity will become more important at all levels of the organization.
Action item. If HR professionals thought that explaining the stock option programs to managers was difficult, just wait until they get a hold of performance equity plans. Think through how the communications infrastructure could handle the added complexity of these programs, and examine how they could be structured to create line of sight between employee behavior and long-term plan payouts.
A peer group is the list of organizations from which the compensation committee collects data to benchmark the company’s top executives. Peer group development tends to involve highly strategic discussions around a company’s true market for executive talent.
Connection to HR. As companies look to marry their executive and broad-based programs, choosing a peer group for senior executives will have implications for data used to benchmark the rank and file.
Action item. Revisit current data sources—especially the ones that tend to be off the shelf—and explore whether more customized data might be available to develop a peer group for the broader population that aligns with the executive peer group.
Relative performance refers to team-based goal-setting on performance-based incentives, which are targeted towards outperforming peers rather than on absolute goals. In a turbulent economy, many companies that can’t predict their absolute results are forced to turn to benchmarking their performance against other companies.
Connection to HR. Tracking relative performance aligns perfectly with the strategic purpose of good HR programs: HR strategy is geared not just toward helping people perform but also to outperform competitors. Look for more incentive programs to include relative performance assessments.
Action item. Identify if there are relative standards—by division, business unit or function—that can be used in an incentive planning process. Note that this might require an investment in third-party data.
Clawback refers to recoupment of previously earned incentive pay in the event of new information about performance. This is an issue endemic to the discussion of risk in compensation. The ability to take back payments can have a substantial impact on employee behavior and decision-making.
Connection to HR. While clawback provisions might be aimed at executives, many policies will apply to all incentive/equity-eligible employees. Developing infrastructure to recoup payments already made can be a difficult process. Additionally, the focus here is on employee behavior; any clawbacks should be constructed in the context of the company’s leadership and talent programs.
Action item. Clawbacks might not be appropriate for every population. Review leadership development programs and assess the degree to which they discourage the same behavior that clawbacks could, which might negate the need for the program to extend far down the organization. Additionally, plan documents and award agreements likely will need to be amended to allow for recoupment of compensation.
Leading with Strategy
Many of those who are tracking the greater integration between executive pay and other HR programs believe, and rightly so, that this is a positive development. However, the actual implementation of this greater alignment is another matter. Organizations that have been successful in creating alignment are those that have a clearly articulated HR strategy—one that maps to and supports business strategy while still remaining dynamic.
Different employee populations will always require different programs, but finding the critical links that align behaviors in the same direction across the organization is the key to a successful integration.
David Wise is a principal in Hay Group’s executive compensation practice. Shawn Hamilton is a consultant for Hay Group’s executive rewards practice and a member of Hay Group’s executive compensation steering committee. Irving (Irv) S. Becker is national practice leader of the executive compensation practice at Hay Group.