November 23, 2020

The Evolving Role of the Compensation Committee: It’s More than Pay

By Robin Ferracone and Dayna Harris

No one will argue that 2020 has been an extraordinary year. From multiple months of COVID-19, the killing of George Floyd in Minneapolis, Breonna Taylor in Louisville, Ahmaud Arbery in South Georgia, among others, human capital management and most notably diversity, inclusion, and equitable treatment and opportunity now command a front seat on the Compensation Committee agenda.

Over the past several years, investors have become increasingly focused on stakeholders. This is not entirely altruistic. Investors want to know that the corporations in which they invest stay healthy for years to come, thus extending the period of time over which cash flows are generated. But the impetus for change is shifting to executives themselves, i.e., change is being driven from the inside out. In 2019, 181 members of the Business Roundtable signed a statement of purpose to lead their companies for the benefit of all stakeholders including employees, suppliers, and the communities where they do business.  The events of 2020 accelerated the corporate focus on stakeholders and highlighted the importance of human capital management and the “S” in ESG. It’s not that companies have been ignoring human capital issues. In fact, there have been notable changes over the years as Chief Human Resources Officers became more involved with talent attraction, retention, succession planning, and linking pay to talent management. The questions that Compensation Committees are asking themselves are, “how broad should their charters be” and “what elements of oversight are best dealt with at the Committee vs. full board level?”

Compensation Committees: A Decade of Evolution

For many years, Compensation Committees focused on their statutory role, i.e., overseeing pay for the Chief Executive Officer and the other top four Named Executive Officers (NEOs), executive program design, and aggregate equity awards Then, as Dodd-Frank was introduced in 2010, Compensation Committees began expanding their purview to include compensation risk management, succession planning, goal-setting (with an eye toward pay for performance), and reporting (as evidenced by signed Compensation Discussion & Analysis (CD&A) reports in proxy disclosures. While “diversity” was in the lexicon, inclusion was not, and Compensation Committees dealt only cursorily, if at all, with such topics. This was the domain of human resources and compliance departments, with high level summaries submitted to Compensation Committee for a review at best.

However, given the importance of creating stakeholder value in today’s environment, Compensation Committees are broadening their focus, which now runs the gamut from all aspects of executive compensation, to diversity and inclusion, talent management, succession planning, corporate reputation, employee engagement, culture, and overall employee well- being. To this end, investors also are demanding a broader agenda for Compensation Committees. In fact, the very name of the Compensation Committee is a strong indicator of this change. Common monikers, such as “Compensation Committee” and “Executive Compensation Committee,” of the early 2000s are giving way to names that reflect the broader agenda. These names include: “Human Resources Committee,” “Management Development Committee, “Organization and Human Resources Committee” “Leadership Development Committee,” and many others. Specific examples include:

Among the largest companies, the “Compensation Committee” name is now minority practice. Smaller organizations are following suit, just not as fast.

Along with the name changes have come changes in charter and the Committee planning calendar. Typical changes to the charter include:

Once these broader charters are set, Compensation Committees are revamping their planning calendars to ensure that the broader items are systematically covered by the Committee. Most of the broader items are reviewed at least annually, so Committee workloads are increasing. In addition to the normal meeting workload, we have seen some Committees add special meetings in order to educate Committee members on the company’s initiatives around such topics as diversity, employee engagement and inclusion, and workforce management, particularly following the COVID pandemic.

Finally, communications to shareholders around the broader “human capital” agenda is becoming more robust. Already, we are seeing human capital management issues reported in special corporate responsibility management (CRM) and sustainability reports. We are seeing proxies include more robust descriptions of human capital management, policies, and practices. And the SEC has issued a rule that companies filing 10-Ks will need to report on human capital metrics that are material to investors’ understanding of the company’s business. This generally means that companies will go beyond reporting number of employees (which they are required to do now), toward more robust reporting on the profile and management of the workforce. Compensation Committee members will be responsible for providing input, reviewing, and potentially approving these disclosures.

The Future of the Human Capital and the Compensation Committee

“The times they are a-changing” may be a bit of a cliché, though in reality the disruption of 2020 has no comparable points in recent memory. Compensation Committees around the world are evaluating the path forward and determining their role in keeping employees and communities safe, creating a diverse and inclusive workplace, and reinforcing cultures of inclusion, all of which in turn will enhance corporate reputation, create competitive moats, and lead to sustainable value creation for shareholders. Shareholders understand this and are using their voice and the current shareholder engagement cycle to ask questions around these broader issues. Moreover, they will use their votes in their election of Directors to reinforce their interests.

Get ready. Investors will be watching the actions of Compensation Committee members to ensure that they are walking the talk. Your continued place on the Board may depend on it.

Robin Ferracone is Founder/CEO and Dayna Harris is a partner with Farient Advisors.

About Farient Advisors
Farient Advisors LLC is an independent executive compensation, performance, and corporate governance consultancy. Farient provides a comprehensive array of services to Boards of Directors and management, including compensation program design, goal-setting and performance measurement, pay and performance alignment, Board of Directors compensation, and shareholder communication among others. Farient is located in New York, Los Angeles, Dallas, and Louisville, and covers clients in more than 30 countries through our partnership in the Global Governance and Executive Compensation Group (GECN).

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