The world of executive compensation has changed during the past few years. Never before has there been more attention paid to the finer details of compensation programs, and the roles of key players in the executive compensation process have changed dramatically.
In most companies, it is now the job of the board compensation committee to govern executive compensation - and for good reason. Board members have a fiduciary responsibility to manage not only the costs of the executive pay program, but also to ensure its link to long-term value creation for all of the company’s constituencies.
However, as the board has taken over the process, some companies have overreacted to the shift in the governance landscape by leaving many Human Resource practitioners - who used to be the strategists and administrators behind the plan - out in the cold. The irony of this outcome is, given the current demands on executive pay programs, it’s more important than ever for Human Resources to play a central and critical role in the process. The best way for HR to do that is to gain perspective on what makes a good executive compensation program and provide proactive support for the committee.
Three Things Every Human Resource Practitioner Needs to Understand.
A good executive compensation program balances three key forces.
1. The company’s strategic needs. An executive compensation program needs to support the organization’s near-term and long-term strategy. Incorporating strategy involves a detailed understanding of how the business makes money and how executives create value. This isn’t an intellectual exercise. This information should provide a baseline for how the pay program should be structured. Human Resource practitioners need to be able to answer critical questions, including:
a) What’s our strategic plan?
b) What’s important for our business to do well this year? During the next three years?
c) Who are our customers, and what do they want?
d) How do we compete, and how are we differentiated in the market?
e) How do we make money?
2. Shareholder concerns. Human Resource professionals in public companies have a broader audience than those in private companies, as public company shareholders demand more attention than ever in the area of executive pay. However, that doesn’t mean private company practitioners don’t have plenty of stakeholders of their own to be concerned about. Stakeholders are not just those who own stock; they can be employees, customers or those in the local community.
In public companies, shareholders have more information than ever before to help them understand the pay program. Under the Securities and Exchange Commission’s (SEC) new proxy disclosure rules, there is enhanced detail in the compensation tables and in the compensation discussion and analysis, a straightforward description of the components of and intent behind the program. As a result, there’s more focus everywhere on the what, why and how of executive compensation.
It’s up to the Human Resource professional to understand all this information and be able to address and support the committee in its understanding of several key issues:
a) Share availability and dilution. Public companies must receive approval from shareholders to set aside shares that can be granted as equity compensation. Once these shares are exhausted, the company will need to go back to shareholders to approve more shares. The more shares granted, the more diluted the value of each share can become.
b) Shareholder proposals. Unhappy shareholders often issue proposals that touch executive pay. “Say on pay” proposals, where shareholders would be given an advisory vote on executive compensation packages, are becoming much more popular.
c) Internal equity and fairness. Employees are spending more time thinking about how much more the boss makes than they do. Pay levels seen as excessive by the rank and file can lead to disillusionment and resentment, which can inhibit a team-oriented culture.
d) Pay for performance. All shareholders now expect the value created for executives to be similar to the value created for their shares - and rightly so. The acid test most will use will be able to correlate the change in value of their shares with the amount of executive pay.
e) Community impact. Members of the local community - whether they be residents, interest groups or customers - may need to be addressed as well. If a company action resulted in a specific adverse outcome for any group, there should be pay-related implications.
Addressing these issues doesn’t mean having all the answers. Rather, it means ensuring these items are part of the discussion, that any needed supporting information is identified and collected, and that the committee is being properly informed.
3. Understanding your executive talent. What your executives think, feel and expect matters. Who they are and how good they are also matters. Without the right executive team in place, strategy and tactics will only get you so far.
It isn’t only HR’s job to understand what drives your executive team to perform - now it’s also the compensation committee’s. The problem is most committees do not interact regularly with the broader executive team and generally don’t have a read on what’s on the executives’ minds when it comes to the pay program.
Here’s where Human Resource can provide the committee with a very valuable perspective - the executive value proposition. We all know compensation and benefits - or extrinsic benefits - only make up two pieces of the executive value proposition. The other pieces are the intrinsic benefits, which include items such as the organization’s mission and/or vision, its culture and climate, its people, its brand, even belief and interest in its products. It’s all the rewards that help the executive understand why he or she wakes up in the morning.
The compensation committee can’t get this information on its own. It takes someone who knows the organization, the business and the people to understand and articulate all the components of the value proposition for executives. What’s important for the committee to know is where pay ranks on a relative basis against the other components of the value proposition.
Three Critical Areas of Compensation Committee Support
A good compensation program design will take a common sense approach to the three perspectives discussed here, and provide the committee with the support they need to make executive pay decisions. There are three tactical areas in which Human Resource can have ground-level impact on the executive pay program.
Target pay philosophy. Every compensation program needs to have a compensation philosophy that provides guidance on a variety of issues, including the company’s target pay positioning in the market. Increasingly, companies are developing compensation philosophies that target the 75th percentile of total pay. While there may be good reasons for a company to target an above-median pay posture, it’s not the right choice for everybody.
There is a correct way to determine what the right target competitive positioning is, and nobody is better suited to inform that process than HR or talent management practitioners. The right competitive positioning should be a function of the executive value proposition discussed early along with the readiness and availability for talent in those roles.
Human Resource should provide information for the compensation committee on:
a) The executive value proposition.
b) The state of talent currently in the executive roles.
c) The bench strength to fill those roles externally.
d) The availability of talent to fill those roles externally.
e) Existing plans for talent development, along with several alternatives.
Within the value proposition, the larger the intrinsic (e.g. non-pay) benefits pieces are, and the greater the ability to recruit for the executive team roles, the less a company should need to target above-market pay positioning. However, if the job isn’t meeting other intrinsic executive needs, and/or if the availability of comparable executive talent is scarce, it can be reasonable for a company to consider above-market pay levels.
Pay mix. This refers to the proportion of the compensation package in the form of guaranteed vs. performance/at-risk pay. The guaranteed components - base pay and time-vested restricted stock - often are used for retention purposes. The at-risk components - short-term and performance-oriented long-term incentives such as stock options and performance equity or cash plans - can be used to incent the achievement of specific results. The different elements offer companies the opportunity to tailor the structure of a pay program to the needs of its business and its executives.
Shareholders and the media are paying more attention to this mix, and any pay package not weighted heavily toward the at-risk components will be questioned. Packages heavy on base pay and time-vested restricted stock will be under certain scrutiny. HR must be aware of how talent competitors structure their pay mixes and provide the committee with this information, along with a rationale for different mixes based on the company’s strategic needs and executive population.
Performance Measurement. What is the company measuring - and at what levels - for organization-wide results and individual performance? The performance measures and levels chosen never have been under more scrutiny as the SEC cracks down on public company disclosures in this area. HR should provide the committee with baseline information on:
a) Key areas of company-wide or divisional performance measurement for the company.
b) The company’s historical performance on each measure.
c) Alternatives for individual performance measurement that are not company-wide, such as personal and/or staff development.
Doing this well requires that HR have a detailed understanding of the strategic plan and shareholder concerns. The success of any short- or long-term incentive plan design lies in the measurement.
While it’s the compensation committee’s job to manage this process, without the right support, committees may operate without the information they need. These days, many committees have compensation consultants, but most need critical internal perspective and resources that consultants can’t provide. The changing landscape for executive pay has created a unique opportunity for the Human Resource practitioner to be this internal resource.
Tags: Compensation and Benefits, Corporate Culture, Employee Engagement, Performance Management, Recent Trends in HR, Strategic HR
