February 1, 2011
New Year Resolutions for Compensation Committees – 2011
This article originally appeared on Robin A. Ferracone’s “Executive Pay Watch” blog on Forbes.com.
This week I want to welcome our first guest blogger, Simon Patterson, from Patterson Associates LLP headquartered in London. Simon and I were partners together at Strategic Compensation Associates (SCA) and have recently created a global alliance between my firm, Farient Advisors LLC and Patterson & Associates, to ensure that our clients are provided the most reliable executive compensation solutions wherever they do business. Simon originally wrote this piece in December, 2010, for the United Kingdom’s (U.K’s.) Executive Compensation Briefing.
Since today is February 1, 2011, New Year’s resolutions are either well underway or broken. I hope you enjoy Simon’s 10 resolutions around executive compensation as much as I did. Even with the U.K. colloquialisms, you might see some of your own resolutions in Simon’s top ten list below.
New Year Resolutions for Remuneration Committees – 2011
1. Make a difference
People do what you pay them to do. If a pay programme rewards the growth of assets, then you can expect the management to start making acquisitions. If you want executives to focus on profitability then don’t reward the growth of revenues. The Compensation Committee has an enormously important role in shaping the design of incentives to ensure shareholders get the performance they are looking for. So why not ask yourselves a simple question: “What are we paying [management] for?” If you can’t answer that question now, you must be able to very soon.
2. Say less, mean it
Have a look at the Directors’ Compensation Report in your Annual Report? Are you asleep yet? I thought so. Now, try to imagine you are an investment director who is making that all important decision – where to put place his or her fund. Will she go for the company which takes 14 pages to tell her that the management team are probably as confused as she is about how much they will make in three years, or will she choose the company which spells out how improving value is their top priority, how that can happen, and how the management team will then be rewarded.
3. Value-based decisions
It is worth remembering that the stock market works. Despite the noises off-stage, investors are remarkably canny at spotting the basics of value creation – cashflow today, with the prospect of more cashflow tomorrow. They also have the ability – through the mechanism of the market – of valuing companies in a surprisingly accurate way, very quickly. So bear this in mind when you are setting goals for the management team. If the sum total of management’s performance aspirations for the coming year – the budget – will not actually deliver what investors already expect, then only one thing can happen. They will re-value the company and value will be destroyed. This isn’t a disaster, but nor is ‘beating budget’ a maximum bonus payout.
4. Bonus – is it an entitlement?
It’s certainly a dirty word these days. Take a moment to consider what a bonus is for. A bonus is a sum of money, paid by the owners of the business, for extraordinary results over and above an individual or team’s “day job”. Apply that test to the list of bonus recipients in front of you and see if you can distinguish that element of the ‘bonus’ which is actually an entitlement – without which the retention of the employee(s) could be at risk – and that element which is clearly paid for through performance which had come as a pleasant surprise to the Board. The latter is a bonus. Now, what are you going to do about the first part, because it isn’t variable pay!
5. Remuneration Governance can be fun
Most companies approach the prospect of a dialogue with remuneration governance professionals as if they were about to waste precious time with an eccentric grandmother having afternoon tea. The sense is that all this wonderful analysis calibrating performance goals and benchmarking pay will somehow get lost, and the conversation will boil down to “I wouldn’t do that if I were you, dear”, or just “don’t”. Although it remains true that the process of engaging with shareholders on the topic of executive pay must be managed carefully – so there are no surprises – the content of the discussion can be very interesting. It has always surprised me how companies fail to appreciate how a good argument usually wins the day. Those who work in remuneration governance may be manning the ramparts on behalf of shareholders, but they want the programmes to work. They are far less interested in ‘benchmarking’ or ‘prevalence’ (i.e., what are the others up to) and more interested in a powerful argument about why executives should be paid differently.
6. Check your tail
It is likely, particularly if base pay has been frozen for a year or two, that you will be faced with a decision to increase salaries by at least a modest sum early this year. Before you sign off that “inflation plus x” figure, take a look at the full cost to the company in terms of pension contributions. It may surprise you. It will certainly leave you feeling less guilty that the increase is probably lower than the executives were looking for and, quite possibly, less than you feel they deserved.
7. Calibrating good performance
Take a moment and draw a large ‘L’ on a piece of paper. Now, along on the bottom write the details of what you think performance could look like next year, with “outstanding” towards the far end and terrible performance close to where the two lines meet. On the vertical line write in how much bonus could be paid if performance is terrible, how much if it is outstanding and the points in between – be honest. When you have marked with an “X” how much bonus is paid at each level of performance, and connected the “Xs” with a line, you have a reward curve. See what happens when you cap pay. Where did you cap it? How much bonus was paid when performance was terrible? More than you’d like, perhaps. This basic tool, which works on the back of an envelope, will move your discussions further, faster.
8. At your discretion
When executive pay is reasonably stable, there is an argument for benchmarking pay against a basket of similar organisations – selected because talent either leaves for those kinds of companies, or is recruited from their kind. But when the market is in turmoil, benchmarking is by no means a simple matter of studying market reports. Take a moment to consider how close your decision-making on pay actually resembles the market mechanism. How closely would you like your company’s remuneration governance to resemble that of soccer management in the United Kingdom? That is how the market actually operates. So don’t be squeamish about mentally preparing to fire your Executive Directors when considering his or her value to the organisation.
9. Defend yourself
You have a vital role. You are being asked to judge what the shareholders are looking for, what is happening in the market for talent, how the management really are performing, and how executive pay should move – given all of these various moving parts. If you have done your homework, no-one is in a better position to be able to make the decisions you are required to make, and therefore shareholders should listen to what you have to say. So, defend yourselves vigorously in the media, with shareholders and with the management team. The management will be heartened to know that your sleeves are rolled up, and you will earn a respectful hearing.
10. Read the papers!
The Remuneration Committee papers, that is.
Robin A. Ferracone is the Executive Chair of Farient Advisors, LLC, an independent executive compensation and performance advisory firm which helps clients make performance-enhancing, defensible decisions that are in the best interests of their shareholders. Robin Ferracone is the author of a recently published book entitled Fair Pay, Fair Play: Aligning Executive Performance and Pay, which explores how companies can achieve better performance and pay alignment. Robin can be contacted at email@example.com.
Simon Patterson is founder of Patterson Associates LLP. Previously, he was a Partner at SCA Consulting and a Worldwide Partner with Mercer HR Consulting in London, where he led the executive compensation service line of Mercer’s Performance, Measurement and Rewards (PMR) Practice. He is actively engaged as advisor to the Remuneration Committee of several FTSE100 companies, and consults widely on the topic of executive compensation and performance measurement. Simon can be contacted at firstname.lastname@example.org.