Session Roundup: The WorldatWork 2015 Total Rewards Conference

Equity Methods was a sponsor of this year’s Total Rewards Conference, hosted by WorldatWork in Minneapolis from May 18 to 20. In addition to some great networking, we took in a number of interesting sessions. Here’s a sample, along with my summaries.

Effectively Communicating Your LTI: Connecting the Needs of the Committee, Plan Participants, Legal, and Accounting

Our CEO, Takis Makridis, served on this panel with Bonnie Kelly (Hilton Worldwide), Dan Laddin (Compensation Advisory Partners), and Sanjay Patel (Kraft Foods). They discussed the importance of connecting key functions to avoid negative surprises in designing and executing a long-term, performance-based incentive program. Total shareholder return (TSR) awards in particular can generate cost explosions that negatively affect plan participants or values disclosed in the proxy.

Accounting needs a heads-up on plan design changes and terminations exceeding specific materiality thresholds. Legal needs to understand the business objectives behind plan terms. Given the complex financial variables present, don’t confuse big words in a grant agreement with precision and accuracy. Instead, Accounting and Compensation should carefully review the legalese to make sure there’s alignment with what was envisioned upfront.

Provide the compensation committee with pre-grant modeling and analytics to help manage expectations. Never ask corporate communications for work product at the 11^th hour, because they need a long lead time. Finally, give plan recipients real-world payout examples, communicate with them when they’re captive (e.g., during year-end performance discussions), and keep them apprised of their award status post-grant.

Executive Compensation 101: The Fundamentals

Sandra Pace and Nora McCord of Steven Hall & Partners gave a crash course on the basics of executive compensation. Executive compensation includes base salary, the annual bonus program, the long-term incentive program, retirement benefits, and other benefits and perquisites.

Base salary is typically 15% – 25% of executive pay. The annual incentive program is based on one-year performance goals, and it’s common to have multiple operational metrics correlated with long-run value creation. The bonus potential is typically a percentage of base salary paid out according to a matrix with upside and downside relative to a target.

Long-term incentives are intended to reward achievement of goals that exceed one year and index executive wealth creation to shareholder value creation. The main types of long-term incentives are time-based stock options/SARs, time-based full value awards, and performance based full value awards or performance-based stock options. As a general rule, performance-based equity exceeds 50% of the LTI portfolio.

Benefits and perquisites are becoming less prevalent, especially the use of single trigger change in control clauses and excise tax gross-ups. Meanwhile, share ownership guidelines are growing in prominence, as are clawbacks.

Global Executive Compensation Growing Pains

Steven Beilke (3M), Blair Jones (Semler Brossy), Barbara Klementz (Baker & McKenzie), and Steve Pennacchio (Pfizer) discussed the global challenges of equity awards. US companies have become much more global, with roughly 30% of sales coming from abroad.

Most companies issue awards globally using the same share and dollar values as those used in the United States. However, this isn’t necessarily a best practice. Larger, more sophisticated companies adjust dollar values and quantities to fit the salary profile of each region, which leads to better consistency and avoids imposing awkward situations on local managers.

Companies should administer and retain tight control over the program at the US headquarters. They also should use a global award agreement to provide flexibility for mobile employees, and be prepared to issue different equity vehicles to match the labor and tax laws of different regions. Above a certain level of seniority, a global policy can make the most sense because it insulates mobile employees from the whims of local country policies.

Putting the Long-Term Back in Long-Term Incentives

Nathan O’Connor (Equity Methods), Steve Pennacchio (Pfizer), and Eric Hosken (Compensation Advisory Partners) showed evidence suggesting most performance-based plans are really mid-term programs, unlike their predecessor stock option programs. For example:

• Between 2003 and 2010, stock options declined from occupying 50% of an overall LTI portfolio to only 30% (the replacement vehicles include time-based restricted stock and performance-based awards).
• Most performance-based equity has a three-year performance window. In contrast, options are usually held for five to seven years before they are exercised.
• An empirical study by Equity Methods found that even vesting periods have become shorter.

Pfizer has a long product development life cycle, starting with R&D and extending all the way to patent acquisition and market launch. They need their compensation programs to match short-run needs (marketing existing products), mid-term needs (getting new products to market), and long-run needs (developing new products from scratch). Pfizer’s mid-term TSR program resembles those in use by most other companies. The long-term program derives a payout after five years and seven years based on the absolute stock price increase plus dividends.

To keep executives focused on the long run, companies should consider adopting share ownership guidelines and evaluate longer-run awards (such as a TSR award with an extended performance period). Another approach would be to reassess stock options. Finally, some companies are adopting post-vest holding periods.

Dare to Be Different: Resisting the Executive Compensation Norm

John England (Pay Governance), Steve Harris (FW Cook), and David Swinford (Pearl Meyer & Partners) facilitated a discussion about resisting the urge to design awards based on common trends. Taking the road less traveled in award design is costly and controversial. But it’s important to ask what characteristics of the business are different and how compensation should tie into those unique features. Here are a few of the ideas they shared:

• Look for ways of rewarding long-run value creation and not creating excessive short-term incentives
• Use regression-based modeling to identify operational metrics that are correlated with shareholder value creation
• Reassess stock options as effective equity vehicles
• Create more extreme upside opportunities for extreme executive value creation

For example, Exxon dared to be different with its well-regarded equity program, which is truly long-term in nature (10 years) given how long Exxon’s business cycles run. By contrast, Eastman Kodak’s compensation program focused on short-term performance and pushing existing products. As a result, the program interfered with the business’ need to reinvent itself in response to the digital revolution.

Companies that dare to be different will need to actively sell anything unconventional to internal and external stakeholders. This should start with a shareholder outreach campaign that includes compensation committee members telling the story from their perspective. The story should link innovative compensation features to the business model. Shareholder constraints may still require bold ideas to be pared back or rolled out gradually.