CFO Magazine – Balance Due: Boards seek the optimal compensation formula to satisfy all sides in the conflict over executive pay packages.

July 27, 2017

By: Keith Button

Structuring executive compensation is a delicate balancing act that isn’t getting easier. Pay plans have multiple goals — attracting and retaining top talent, motivating performance, and keeping activist shareholders at bay — that are often at odds with each other.

Ostensibly, both shareholders and the boards of directors that set executive pay want management leaders, particularly CEOs and CFOs, to carry out the business strategy that is judged to be the best path to long-term company growth and share-price appreciation. Most agree the best bet for accomplishing those outcomes is a strong alignment of pay and performance.

Yet, when it comes to how and how much executives are paid, there are numerous areas of concern for the various stakeholders, which, in addition to the investors and directors, include analysts, employees, and of course the executives themselves. The growing income inequality in the United States has many groups criticizing executive pay, especially CEO compensation, as excessive and unwarranted. Investors want stronger links between pay and performance, but tempered with policies that give executives real “skin in the game.” Executives themselves want to be compensated appropriately for their abilities and results.

Compensation committees today are busily tweaking their pay policies to address all of those concerns. But many are struggling to find a balance between demonstrating good governance and justly rewarding and retaining top executives.

Treading Carefully

Results of the nonbinding shareholder advisory votes on executive pay packages, required for public companies by the Dodd-Frank Wall Street Reform and Consumer Protection Act, have indicated that investors are generally OK with executive compensation programs. They’ve given a majority thumbs-up about 96% of the time, and in more than 90% of cases the approval rate has been at least 80%, notes Rick Smith, a managing director in the global employer services practice at BDO.

That suggests companies are spending sufficient time connecting executive pay to the business plan and doing a good job explaining the structure in proxy statements, Smith says.

But boards shouldn’t take too much solace in those results. In structuring pay plans, boards’ compensation committees must keep in mind that they understand the company’s particular needs in a way that few outsiders — even some large institutional investors — can, says Marc Hodak, a partner at compensation consulting firm Farient Advisors. In the current climate, however, they run a real risk of alienating shareholders if their actions don’t appear to have a justifiable motive.

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