Setting a compensation programme for senior executives is a bit like walking a tightrope.
On one hand, compensation directors are under pressure to offer competitive packages to attract the brightest executives. On the other hand, there is pressure to ensure remuneration packages are not excessive and align with business strategy. Complicating matters is the intensifying scrutiny – by investors and the media – over C-suite pay, particularly for publicly listed companies.
Compensation committees, also known as remuneration committees, consider current pay trends, peer practices and competitive data in setting pay. In its report, The 2013 Compensation Committee Agenda: Go Beyond, Pearl Meyer & Partners, a global consultancy that specialises in compensation, offers tips on how to create a well-tailored compensation strategy:
1. Aim for business-based plans. “Compensation should reflect the needs of the business,” the Pearl Meyer report says. The committee’s goal is to build or sustain a great company. Management must propose programmes that meet regulatory standards, the report says, but also drive key priorities and strategies to ensure long-term success. To achieve this, they should use discretion rather than relying solely on formulaic compensation programmes. For example, with median pay philosophy, committees should be flexible and “vary pay levels in response to factors that are specific to the company or the individual,” the report says. The explanation of pay policies for executives should be conducted every year, and investor feedback should be part of the process.
2. Link realisable pay to compensation programmes. “Understanding pay targets is important, but analyzing actual pay relative to actual performance gives committees real, actionable information,” the report says. Realisable pay, which is gaining in popularity among businesses in the US, measures all non-incentive compensation and the updated value of equity or long-term cash incentive awards made during a measurement period. It covers base salary, bonuses, share-based awards, long-term cash awards, stock options and other forms of compensation. Historical realisable pay data should be used as benchmarks for setting future performance goals and incentives, according to the report. Realisable pay metrics should also be communicated to shareholders and as part of a proxy season postmortem, the report says.
3. Focus more attention on performance. “There are two sides to the pay-for-performance equation. It’s critically important to get both sides right,” the report says. Compensation committees should give more consideration to incentive measures, setting challenging but reasonable performance goals, according to Pearl Meyer. Committees should avoid reliance on common industry performance benchmarks. They should focus on outcome-based metrics, such as revenue, earnings, and return on investment. These reflect immediate past success and should be complemented by metrics that drive future value creation, the report says. Examples include the development of new products or strategies as well as standards for customer service, quality and sustainability.
4. Rethink equity awards. “Equity awards typically represent the lion’s share of an executive’s performance opportunity in the short term and over time,” the report says. Equity is more valued as a way to retain valued executives, as benefits such as pension plans have declined. “While outsiders often are critical of time-vested grants and retention awards, boards know that a bench of talented leadership is essential for internal succession and business continuity,” the report says. Adjusting the amount of annual equity awards based on past performance can prevent the chance of target pay remaining at median levels regardless of future performance.
5. Customise the risk/reward profile to the business. “Compensation plans should evolve to reflect the business risks and HR needs of companies at different lifecycle stages,” the report says. “Overly leveraged” incentive plans can lead to aggressive management decisions, while risking too little pay can promote a “pay for pulse” culture, according to Pearl Meyer. Compensation plans should be designed to reflect the risk appetite of the company and the company’s HR priorities.
Related CGMA Magazine content:
“CFO Pay Rises, but Subjective Bonuses Rankle Finance Chiefs”: CFOs are dissatisfied with the number of bonuses awarded subjectively, according to the American Institute of CPAs/Arizona State University 2013 CFO Incentives and Compensation survey.