Public company compensation committees operate in an increasingly challenging environment. They must balance the interests and perceptions of, and manage communications to, executives, employees, current and potential investors, the media and communities in which the company operates, all against a backdrop of complicated tax, securities and employment laws and competitive considerations. Committee members, in particular the chairperson, are frequently tapped for input and approval and usually work closely with internal and external legal counsel, compensation consultants and the executive team in order to thoroughly evaluate all factors relevant to compensation decisions. This article provides five tips to assist compensation committee chairs in navigating these demands.
1. Be Mindful of Overarching Committee Responsibilities
Stock exchange listing standards require boards of directors to establish a committee of independent directors the duty to oversee executive compensation and certain related matters. This board delegation is made via the committee’s charter and may be broad or narrow, depending on the company’s circumstances and the nature of board dynamics. For most compensation committees, key responsibilities include the following:
- approving or recommending to the board for approval executive compensation arrangements and performance goals that link pay to company strategies and performance (which, for the CEO, must occur outside of his or her presence);
- considering whether compensation programs motivate the appropriate level of corporate risk-taking;
- clearly communicating compensation strategies and decisions to executives, employees and shareholders, including via the Compensation Discussion and Analysis and related proxy statement disclosures;
- approving all equity grants and management share pools in accordance with the company’s equity incentive plan and any equity grant policies; and
- overseeing the negotiation of executive employment agreements and the administration of other compensatory agreements, policies and plans.
Committee chairs should prepare meeting agendas with an eye toward the committee charter, in order to ensure that the committee addresses all of its enumerated responsibilities.
2. Stay Attuned to Compensation Trends as well as Company Strategy
Compensation programs must adapt to ever-evolving executive and shareholder preferences in order to retract and retain talent, provide appropriate tax treatment to executives and the company and facilitate company messaging regarding pay for performance, internal pay equity and any other identified goals. It is important for compensation committee members, particularly the chair, to stay attuned to trends in order to anticipate requests from executives and other constituents and to refine performance programs and goal-setting. At the same time, committees must recognize and be prepared to communicate to all constituencies that customized elements of pay may be a better fit for the company’s unique position and strategy, and therefore more appropriate than the “best practice” standard.
3. Win the Say-on-Pay Vote
The EY Center for Board Matters reported that in 2015, investors were three times more likely to vote against compensation committee members at companies with low say-on-pay support, even in the first year of the low vote. Institutional Shareholder Services (ISS), the leading proxy advisory firm, votes on a case-by-case basis for members if the company’s previous year’s say-on-pay proposal received less than 70 percent of votes cast, taking into account engagement efforts and actions to address the issues that contributed to the low level of support, and applies heightened scrutiny for proposals with lower than 50 percent approval.
In order to drive high say-on-pay support, focus on linking executive pay to performance and using infographics and easy-to-read summaries to clearly explain pay practices and programs in the company’s proxy statement. If special shareholder engagement is required on the topic of compensation, coordinate with legal counsel and the executive team on messaging prior to acting as an ambassador for the company. Compensation committee members and chairs are involved in approximately 20 percent of investor discussions on pay.
4. Prepare for Upcoming SEC Rules and Related Investor Communications
In 2015, the Securities and Exchange Commission carried out rulemaking on various Dodd-Frank Act initiatives which are likely to shape future say-on-pay votes and director elections.
Pay Ratio Disclosure: In August 2015, the SEC finalized the “pay ratio” rule, which will require public companies to disclose the ratio of CEO pay to the pay of the median employee beginning in the 2018 proxy statement. Identifying the median employee can be a time-consuming and complicated process because it requires gathering information from global operations, coordination among staff across numerous company functions and consideration of current and future messaging to investors, employees, communities and media. Accordingly, compensation committees should begin discussions with the company’s executive, HR and IT teams regarding the company’s strategy and confirm that necessary systems are in place to gather and evaluate data.
Clawback Policy: In July 2015, the SEC proposed clawback rules, which would require listed companies to adopt and disclose policies to recover executive incentive compensation in the event of an accounting restatement. Recovery would be required without regard to fault. At a minimum, public companies should be including clawback language in current employment agreements and plans in order to support a contractual basis for recovery under existing and future policies. Companies may also want to consider using non-financial performance metrics when awarding incentives to executives who are not involved with accounting and finance matters, and begin tracking all incentive-based compensation paid to executives. Once the SEC and related exchange rules are finalized and effective, compensation committees will need to formulate and oversee compliance with a policy that satisfies the new rules.
Pay for Performance Disclosure: In April 2015, the SEC proposed rules to require public companies to disclose the relationship between executive compensation and financial performance. The rule will require presentation of actual pay to executives of the company as compared to the total shareholder return of the company and peer group companies for the last five years. This rule is unlikely to be finalized during the 2016 proxy season, but compensation committees should be mindful of anticipated future disclosure when determining executive compensation, and consider the link between company pay and total shareholder return. Total shareholder return is also an important factor for ISS in its evaluation of the say-on-pay advisory vote, but may be just one of many factors the compensation committee evaluates when setting pay.
Hedging Policy: In February 2015, the SEC proposed rules to require public companies to disclose whether directors, officers and other employees are permitted to hedge the value of equity granted to them as compensation. This rule is unlikely to be finalized during the 2016 proxy season. Many public companies already prohibit hedging for all directors, officers and employees under their insider trading policies.
5. Focus on Communication
Effective communication underlies all of the compensation committee’s responsibilities. A positive working relationship with the executive team is necessary in order to establish and convey the structure of the compensation program, articulate the performance it is intended to incentivize, define acceptable levels of risk-taking, share the results from annual performance evaluations, discuss company and individual areas of strength and weakness and affirm the value of each executive to the team. At the same time, the committee must work with the executive team and committee advisors to communicate the quality of the executive compensation program and related matters to employees, investors and other constituents. This messaging should articulate the company’s compensation philosophy and goals, such as pay for performance, internal pay equity and recruitment and retention, and demonstrate the pay programs’ alignment therewith. Although it is important for all members of the compensation committee to be mindful of these issues, it is particularly important for the committee chair to be a skilled communicator because he or she often ends up liaising with consultants, legal counsel and executives to finalize sensitive compensation decisions.