NACD Recap: Trends and Emerging Issues in Executive Compensation
Executive compensation is continuing its shift to performance pay. Compensation design and proxy disclosures are becoming more complex. And investors and proxy advisors are continuing to increase their influence on compensation issues.
Those were the key themes at the March 23 chapter meeting of the National Association of Corporate Directors (NACD) in Tempe, Arizona.
Our CEO, Takis Makridis, joined a panel discussion with Rob Main and Bob Mittelstaedt. Rob is head of the corporate governance team at Vanguard, and Bob is dean emeritus of the W.P. Carey School of Business at Arizona State University. Bob is also on the boards of three public companies.
Moderator Jack Zwingli, formerly of ISS Incentive Lab, kicked off the discussion. On the subject of performance pay, everyone on the panel agreed it remains the right answer for executives—the devil is in the details. Bob pointed out the importance of keeping executive behavior in mind. If there are too many overlapping performance metrics, or if they’re too opaque, executives won’t engage with awards. Neither will they drive the desired outcomes. The holy grail, Bob said, is to simplify and try to stay consistent year over year.
Rob added that the most important criterion for investors isn’t the metric itself, but the disclosure. If the CD&A clearly describes how the compensation instruments link to long-term corporate strategy and performance, investors will give companies fairly wide discretion on those metrics—especially if there’s no disconnect between shareholder returns and how the awards pay out to executives.
To Rob’s point, Takis noted that the rise of hybrid awards (incorporating a TSR “kicker” on top of the core performance metric payout) reflects an effort to simultaneously drive shareholder alignment and executive line of sight. Takis also brought up the difficulty of setting supportable threshold, target, and stretch goals. Committees and investors are now saying, “Prove that your stretch target is really stretching!’”
To solve this problem, Takis said, begin with reviewing internal FP&A analyses. Then broaden the review to include analyst estimates and empirical tools for stress-testing the levels.
Increasing complexity isn’t limited to award design and metrics. Bob observed that LabCorp now devotes over 40% of its 85-page proxy to executive compensation. Combined with more required disclosures coming down the pike as a result of the SEC’s Dodd-Frank rulemaking, Takis said, there’s a growing dichotomy with how companies approach their disclosures. That is, some do the bare minimum, parachuting the required numbers into their proxy without much additional context. Meanwhile, others build a narrative around the required figures with supplemental analysis to tell investors why the numbers are what they are. Visualization is very much the next frontier.
So will the proxy of 2020 be any shorter than today? Rob doubted it. Vanguard, he said, certainly cares about compensation governance issues such as pay magnitude and excessive discretion, but the CD&A is crucial. First and foremost, the firm looks for a clear link between pay structures and business strategy. Rob highly recommended using charts and tables to cut through the noise and summarize important information.
As for activist investors and shareholder engagement, Bob noted that the makeup of a shareholder base drives strategy with the companies where he serves on the board. For instance, LabCorp is 60% institutionally owned, so regular and open communication with those institutions is crucial. On the other hand, W.P. Carey Inc. is a REIT with 60% individual ownership, making proxy solicitation especially important.
Bob warned against taking a “check the box” mentality in response to influence from proxy advisory firms. Rather, companies should do what’s right for the firm and investors, then make sure other important items are covered. Takis agreed, remarking on the recent trend toward heterogeneity and customization in compensation structures. From an investor perspective, Rob added, the best way to avoid shareholder disputes (or worse) is to be proactive. That is, engage with shareholders early and often to take care of any budding issues before they become major points of disagreement.
Overall, the NACD discussion highlighted the importance of being active and deliberate in all aspects of executive compensation. Best-in-class companies set consistent metrics that link to long-term company performance, establish targets that are quantitatively robust, put together disclosures that concisely and cleanly address key investor concerns, and proactively engage with shareholders on important executive compensation topics.