Today, the Conference Board’s Task Force on Executive Compensation released a report detailing its guidelines for implementing effective executive compensation programs for public companies. The Task Force was convened in March 2009, and consists of corporate directors, investors, academics and experts in compensation, corporate governance and law.
In the press release accompanying the report, Robert E. Denham and Rajiv L. Gupta, co-chairs of the Task Force, stressed that compensation committees and boards of directors must be free to develop compensation programs that reflect their shareholders’ interests and fit the companies’ business objectives, and therefore proposed a “principles-based” set of guidelines for its recommendations. Messrs. Denham and Gupta contrasted this “principles-based” approach with a “rules-based” approach and noted that a “rules-based” approach could not substitute for thoughtful board actions discussed with shareholders, and therefore wanted to develop a practical set of guidelines for public companies.
The five “Guiding Principles” recommended by the Task Force are the following:
Compensation Linked to Strategy and Performance. An effective compensation system is one that incents achievement of the objectives of the company’s business strategies, and uses performance metrics that measure performance against the desired objectives. Incentive compensation should be focused on building long-term value creation for the company, just as a company’s business strategy should be focused on building long-term shareholder value. A significant portion of executive compensation should be designed to encourage the longer-term success of the company. Incentive compensation should not encourage excessive or inappropriate risk-taking, nor discourage an appropriate level of risk-taking that the board of directors determines is necessary to accomplish the company’s strategy.
Attractive, Affordable and Fair Compensation Aligned with Actual Performance. The Task Force reported that poorly executed benchmarking by companies resulted in the spiraling of executive compensation in recent years. The selection of peers to benchmark is crucial. Benchmarking should take into account performance differences among the company and its peers. The Task Force recommended targeting executive compensation above median pay as determined by the benchmarks only when there is appropriate justification.
Avoid or Eliminate Controversial Pay Practices. The Task Force discourages the use of controversial pay practices that have come under heightened scrutiny, such as compensation without regard to performance, “golden parachutes,” stock option repricing, gross-ups for tax consequences of parachute payments, and multiyear employment agreements with generous severance packages. Features such as these should only be used when substantial justification exists, for example, during a period of corporate challenge or circumstances requiring executives with special expertise.
Independent, Experienced and Knowledgeable Compensation Committees. The Task Force acknowledged the importance of compensation committees in building and sustaining public trust. To maintain the independence, experience and knowledge of the compensation committee, members should have access to and control the engagement of key advisors, who also should be independent of management.
Foster Transparency and Dialogue Between Boards of Directors and Shareholders. The Task Force emphasized the importance of transparent, easily understood compensation programs. Overly complex or esoteric arrangements should be avoided. The Task Force encouraged companies to improve the engagement and dialogue with shareholders with respect to executive compensation. The Task Force noted that federally mandated advisory votes on executive pay were increasing likely, and therefore shareholders and corporations have responsibilities to ensure that an advisory vote on executive pay is effectively implemented, and facilitates dialogue between shareholders and boards regarding executive compensation.
The Task Force urged adoption of the Guiding Principles, and noted that a number of companies have already made this commitment.