Session Roundup: 2015 Equilar Summit

Equity Methods was a sponsor of this year’s 2015 Equilar Summit in Hollywood, FL, from June 10-12. We engaged in a lot of great sessions and discussions. Here’s a summary of what we heard.

A Delicate Balance: HR’s Interaction with the Compensation Committee

This session, moderated by Eric Hosken at Compensation Advisory Partners, discussed HR’s twin goals of representing the needs of senior executives while maintaining integrity with the compensation committee. Challenges include wide-ranging personalities among board members, preparing for committee meetings, and briefing the CEO.

Panelists stressed the importance of briefing the CEO before meetings. Even with aggressive or difficult CEOs, this step is critical to set expectations and correct misconceptions. Another key point was that at least three board meetings should take place before a new plan or change is approved. Rushing the board to approve a plan at first sight is generally not well-received, and can even raise questions of integrity.

Power Lunch Presented by Pay Governance

Pay at the top, and specifically for CEOs, should not be determined based on external comparisons with peers groups.

That was the provocative assertion from Charles Elson during this lunch discussion. Elson, the director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, said that targeting CEO pay at median-or-above peer CEO pay is a practice that systematically results in inflated pay across industry. Instead, companies should base CEO pay on internal comparisons—by considering the pay of direct reports, the CEO’s actual business contribution, and the specific business environment. Peer comparisons should serve only as a reality check, not as a way to set pay levels upfront.

Audience members raised various concerns, particularly over CEO flight risk in an environment of fierce competition for talent. However, Elson contended that while we may believe that a CEO is a good fit for a variety of companies, research shows that CEO skills actually become very specific to a particular company. Success at more than one company is rare, even for lateral hires in the same industry. Elson further observed that pay differences between the CEO and other employees creates a performance disincentive for non-CEO employees, leading to lost business productivity, and other issues.

The Investors’ Perspective

In this session we saw executive compensation from another angle: that of the investors. Panelists from several large institutional investors gave us deeper insight into their voting decisions and patterns. For example, the guidance of governance groups (such as those of ISS and Glass-Lewis) often plays a role, but not a large one, in institutional investors’ voting decisions. In addition, when done properly, investor outreach can also be very effective. But companies must be proactive rather than reactive. Waiting until after a proxy has gone out, and then trying to contextualize changes or questionable practices after the fact, is not productive. Instead, the panelists urged reaching out several months in advance to investors with a purposeful message. Otherwise, it’s just damage control, not a true discussion.

Further, it’s important to understand the difference between those parties of an institutional investor that vote versus those that actually engage in the buy/sell transactions of a company. Investor outreach needs to be targeted to the right group, based on the goals at hand. Another interesting observation raised is that institutional investors have greatly consolidated—only about twenty big players remain.

Executive Compensation 2020: Looking to the Future and Implications for Today

This discussion opened with a look at some trends in executive pay and governance. A study revealed that in the last two years:

  • Executive pay has increased by only 13%
  • Options have seen a dramatic decline in the overall executive pay mix
  • Performance shares have grown to over half of the executive pay mix
  • Say on Pay vote outcomes—the vast majority of companies are passing with 80%+ approvals
  • 90% of companies have implemented share ownership guidelines

Pay-for-performance was a major talking point. Panelists contended that the problem is not that the CEOs of high-performing companies are being overpaid, it’s that CEOs of companies at the bottom to median percentile rankings are all being compensated at the median level. This echoed Charles Elson’s point during lunch that executives should not have target pay based on peers’ success.

The SEC’s proposed rule on pay ratio disclosure is again delayed, but remains a component of the growing public pressure on executive pay. This underscores the need to be proactive in investor outreach. Microsoft, for example, engaged with investors almost a year before its proxy. Despite their generous compensation levels, their Say on Pay initiative passed with strong support.

The Final Word on Executive Compensation and Governance

This session, moderated by Tim Bartl, was about how companies should navigate through an increasingly complex executive compensation environment. The discussion included some of the steps that would prepare companies for success in the 2016 proxy season.

On the subject of pay for performance, panelists agreed differentiating pay designs is key. A distinguishing factor is the rigor of the performance metric. Also essential is the ability to explain why a company has chosen a particular metric and how it drives the total shareholder return.

In addition, cyclical industries need to be very careful in setting their performance targets—it’s expected that they will have cycles of under- or over-performance in various years. Finally, companies need to have a clear understanding of what their peers are doing.

Regarding institutional investors and shareholder engagement, what the CFO tells Wall Street is normally what is being communicated to shareholders. The goal here is to align what a CFO tells the Street with the “story” disclosed in the proxy. Investors can get very skeptical about performance measures that are easily manipulated, such as internal accounting metrics. Companies should be cautious around messaging, especially when metrics are more nebulous.

As for proxy disclosures, visualization is important. More graphs, charts, and bullets will help investors digest information as proxies grow longer.

Challenges and Triumphs in Aligning Executive Pay with Performance

In this session, panelists agreed there has been a bothersome trend toward the one-size-fits-all approach to compensation practices. Pressure from governance groups, along with a natural merging of perspectives among practitioners, are the likely culprits.

The path to more customized plans, said panelists, can sometimes lead away from TSR awards, and TSR awards should not be assumed to be a good fit for everyone. This reminded us of a case presented in a previous panel. Coach adopted a three-year TSR plan just before a restructuring to renew the company’s prospects for long-term growth, because they assumed that was what the industry was expecting. The restructuring led to a short-term decline in stock price, leaving TSR plans under water and the recipients demoralized.

While we agree that TSR is not the right approach for every company, it remains one of the most effective award features from a shareholder and recipient standpoint. Still, in the absence of upfront planning and strategy, TSR plans can backfire. Stay tuned for an upcoming Equity Methods issue brief that elaborates on this important debate.

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