Investor Perspective on Executive Compensation

The Issue

Over the past several years, investors have been laser-focused on executive compensation. From Say on Pay to pay and performance alignment, clawbacks and the CEO to Median Employee Pay Ratio provision, the provisions of Dodd-Frank Wall Street Reform and Consumer Protection Act, pending or otherwise, have created more transparency in corporate disclosures, and measurably improved engagement between investors and companies. With Dodd-Frank in administrative limbo, the ultimate question is not what will the SEC require, but what do investors want from the executive compensation system and are they getting it?

Farient’s Point of View

Over the last several years, Farient has spent time researching what investors want from their portfolio companies. We have looked at the intent of Dodd-Frank within the context of encouraging better communication between companies and investors. We know investors have minds of their own and do not speak with one voice. But several common themes have emerged among investors:

• In general, investors agree they do not want to be in the boardroom. What they want is for board members to do their jobs by planning and making decisions in shareholders’ best interests. Then, they want these companies to clearly and proactively communicate their plans and decisions. These expectations pertain to executive compensation, as well as any other executive matters. The key message here is that investors want regular communications about decisions they deem to be defensible. The good news is that this has, for the most part, become best practice.

• Investors believe executive compensation is a “window into the boardroom.” In other words, if the executive compensation program is transparent, reasonable, and sensitive to company performance, then investors feel as though other aspects of corporate governance will have integrity as well. The key takeaway here is that investors expect the executive compensation programs and decisions to have integrity – e.g., the program design is consistent with the business strategy and needs of the company, and the committee actions are consistent with the program design.

How Farient Can Help

At the end of the day, the objective of most companies is to align the interests of executives and shareholders.

To help evaluate performance and pay alignment, many companies and investors have used Farient’s highly regarded Performance Alignment Reports (PARs) tool. The tool provides a clear illustration of whether a company’s executive pay is reasonable for its size, industry (or peer set), and performance as well as whether pay is appropriately sensitive to performance. With Farient PARs, companies have a better way to:

• Disclose the relationship between pay and performance
• Diagnose alignment problems, and
• Design better aligned compensation programs

Farient PARs provide a means to quantify and visually illustrate the degree to which a company’s executive compensation program is aligned with total shareholder return (TSR) over time.