WorldatWork Total Rewards 2017 Conference Roundup
Equity Methods was at the WorldatWork Total Rewards 2017 Conference in Washington, D.C. from May 8 to 10. We were fortunate to have had the opportunity to present in four different sessions, and we also engaged in a number of sessions from a host of outstanding professionals in the field. Here’s a summary of our experience.
A Whole New World for Executive Compensation? What to Look for in the Year Ahead
Dan Laddin, Steve Harris, and Dave Swinford discussed the multiple dynamics that are set to shake up the world of executive compensation. The talk began with Dodd-Frank and the new administration’s bent toward deregulation. Tax reform will be difficult to get through and should be monitored carefully for how it might affect equity award taxation. The Financial CHOICE Act has strong opposition, but if it gains momentum, it could have substantial ripple effects. No-fault clawbacks are unlikely to be pushed through by Dodd-Frank, but compensation committees are looking at cases like Wells Fargo’s recent clawback and asking if they should be proactively inserting more flexible clawback rules into their own programs.
There was some discussion of CEO pay ratio, which was covered as a standalone topic later on in the conference. Interestingly, a growing number of states, cities, and municipalities are issuing CEO pay ratio-esque legislation. It’s unclear whether this trend would accelerate or slow down if the SEC’s pay ratio rule goes through.
Institutional investors are having more robust dialogues with companies. ISS’s role remains important, but institutions are getting further into the details of pay-for-performance sensitivities as well as how and why metrics align with the business strategy. The panel strongly encouraged pursuing shareholder discussions when not in crisis mode. Be wary of “out of sight, out of mind” investors.
Another burgeoning topic is internal pay equity, starting with gender pay equity. As we’ve spent time on this topic, we can’t stress enough the importance of designing statistically valid experiments that control for the right variables. Doing the modeling is important so you can objectively know what’s going on, but structuring the experiment in a meaningful way is not straightforward.
The panel closed on the topic of ISS’s new financial performance test. As we’ve also alluded to, we think ISS will incorporate non-TSR assessments (e.g., return metrics) in its quantitative screen. Although there’s a lot of frustration at the moment with TSR, non-TSR metrics have their own problems. For one, they aren’t always cleanly correlated with TSR. Two, this may pave the way for ISS to opine even further on goal rigor, whereas at least TSR is easier to benchmark across companies. And, of course, ISS would rely on GAAP financial results, even though most organizations use non-GAAP metrics.
The Arts and Crafts of LTI in Special Situations
This panel, which included Silvana Nuzzo (International Flavors & Fragrances), Sandra Pace, and Joseph Sorrentino, offered a comprehensive overview of how to effectively manage equity awards in M&A transactions.
The first step is to organize a cross-functional deal team that consists of leaders from executive compensation, legal, accounting, and the corporate development function leading the transaction. Next, identify the must-retain people in the acquisition target. Ask questions to understand which positions are the most difficult to staff, or who at the target has knowledge that’s necessary for the unit to operate effectively.
Every deal presents different circumstances. For example, you might determine there are people who are absolutely key for at least 12 months, meaning special effort is needed to retain them at least that long (but afterward, normal LTI granting is satisfactory).
After sorting out the human capital at the target and ways to build out a retention strategy, the next step is to decide what to grant and how much. This is often where peer benchmarking is performed along with pay mix planning. A decision also needs to be made as to whether to assume the outstanding equity of the target. From a share utilization perspective, it’s much better to assume target equity since those shares don’t count against your remaining pool.
These design considerations often prompt acquirers to make a one-time retention grant. Retention grants need not be broad-based and may have very different provisions from normal awards. Retention awards usually occur outside the annual grant cycle and the terms should depend on the objectives. For this reason, special awards can take the form of options or RSUs, be time- or performance-based, and have cliff or graded vesting.
In addition, the target firm and its employees might have less or different experience with equity compared with your employees. Therefore, another key step in the process is charting out a communication strategy. Silvana discussed IFF’s use of “Comp 101” sessions to drive employee engagement with the company’s equity structures.
A quick discussion of spinouts wrapped up this session. At Equity Methods, we’ve dealt with a large number of high-profile spinouts. Each brings its own nuances. For example, the two companies can split equity using either the shareholder approach (treating employees like shareholders) or the employment approach (converting equity to that of the firm employing the individual post-spin). Given all the moving parts, spinouts can also give rise to major accounting and internal controls challenges.
Top 5 Most Common Executive Compensation Issues That Companies Are Facing
1. ISS scrutiny of executive incentive plan design. The panel encouraged the audience to pay careful attention to ISS doing more in the way of grading performance goal rigor.
2. The right eligibility level for LTI plans. Share utilization remains a hot-button concern to many organizations. Compensation committees want to know that equity is being granted sufficiently across the organization. But they also want to know that share proposals won’t be shot down. If high burn rates prevent deeper granting or aggressive retention moves, some companies will ask for approval for separate plans. Alternatively, they may roll out cash-based plans.
LTI eligibility also touches on how to choose grant sizes: formulaically or via a qualitative/discretionary approach. Each has its pros and cons. For example, a formulaic approach that dictates granting a specific number of units to each band level can be perceived as an entitlement. In contrast, a discretionary approach confers more flexibility, but calibration across managers and business units becomes much tougher to get right.
3. Differentiation based on individual performance. Companies are using long-term incentives to differentiate and reward top performers—or even top potential. Tradition often dictates granting similar amounts for a given level. However, some compensation leaders are looking into isolating top performers and top potential for much larger grants. The backdrop? Growing research that top talent disproportionately drives company results.
4. Use of TSR as a performance measure. We were happy to hear this discussion take an analytical bent, including encouragement of more backtesting and quantitative modeling when picking an appropriate comparison group. The speakers observed that some companies wouldn’t have a good peer group, in which case relative TSR could actually worsen the randomness of payouts. We agree, and in these cases we’re seeing greater use of absolute TSR metrics and even a slight uptick in stock option usage.
5. Merit increases vs. market adjustments. Not in the genre of executive compensation—but still interesting—is how some companies are moving away from annual merit increases. Instead, they’re doing periodic market adjustments. We think this is important for every company to consider in light of their human capital strategy. The problem with annual increases is that they can be petty, in which case they may mask material mispricings. (For instance: “Well, Sally got a 3% raise, so she should be happy” instead of “Wait, Sally is worth 20% more than we’re paying her. We should correct that. And these five other people are appropriately priced.”) This is a bold and controversial topic that deserves consideration.
Global Granting—When Equal Grant Sizes Make Sense
Anil Agarwal (American Express), Takis Makridis, and Lindsay Minnis led this session about the ways multinational companies grant equity to like-banded employees in different countries. For example, say you have two senior vice presidents with identical job duties. One works at the corporate headquarters in the United States, and another works in the India office. Should these two employees receive an equity grant of equal value, or should the India grant be adjusted for cost of living differences?
In most cases, companies take one of two approaches. The first is what we call the “peanut butter” or “global” approach, where companies hold grant levels constant regardless of country. The second is the “step-down” or “regional” approach, where companies adjust grant levels outside of the United States for factors such as cost of living differences.
The panel discussed how companies should evaluate their own global equity granting approach, and when it may be time to make a change.
Benefits to the global approach are standardization, an acknowledgement that top talent is mobile, and labor market competitiveness. Benefits to the regional approach are cost minimization and avoiding awkward situations where equity awards are a disproportionally large portion of someone’s pay. A decision to change approach will require careful consideration and planning.
Lindsay explained how securities laws differ around the globe, and why it’s important to vet any approach to make sure it doesn’t conflict with country-level laws. The peanut butter approach is particularly tricky when it comes to complying with international securities laws. The reason is that onerous filing and reporting requirements can be triggered for something as minor as having too many recipients in a particular jurisdiction.
In any case, whatever the approach, be sure to periodically stress-test its appropriateness in light of your evolving human capital goals and challenges.
Get your copy of the presentation here.
The Hybrid Award: Bringing Efficiency to LTIPs?
Mark Breer (Microsoft), Stephen Charlebois, and Takis Makridis led a discussion about how different metrics—such as TSR, financial or operational metrics, and strategic goals—serve different purposes in incentive programs. This contributes to the rising popularity of multi-metric awards, or what we at Equity Methods call “hybrid awards.”
Compensation committees like the appeal of hybrid designs because they offer a way to jointly satisfy internal and external objectives. Internal objectives center around delivering line of sight to executives, usually in the form of financial, operational, and strategic metrics. Externally, investors also want to know there’s an explicit linkage between pay and shareholder value creation (i.e. TSR).
The presenters agreed that an exclusive reliance on just one metric can yield unintended outcomes, whereas fusing two or three metrics together can deliver a more balanced set of incentives. Microsoft’s design is especially unique because it uses TSR and five strategic metrics. Mark explained that Microsoft wants its entire executive team to rally around product and client goals that are central to the organization’s transformation. TSR then sits on top of these metrics to modify the payout and create tighter linkage to shareholder outcomes.
Hybrid designs can vary widely. For example, metrics can be independent of one another. Alternatively, one metric (e.g. TSR) can modify the result of other metrics. Performance timeframes can vary as well. While there’s looming pressure to use only three-year metrics, companies in highly volatile industries may simply be unable to set three-year goals. Relative TSR can soften the blow by functioning as a three-year metric alongside one or more one-year metrics.
Get your copy of the presentation here.
Bang for Your ESPP Buck: Maximizing Perceived Employee Value
Employee stock purchase plans (ESPPs) are back on the rise. Key to their success is to implement a plan and communicate it to employees in a way that fits with each company’s specific culture. That was the message from this panel, where David Outlaw joined Brit Wittman (Intel), Julie Mrozek (Leidos), and Cherie Curry (Hilton).
Optimizing ESPPs comes down to “bang for your buck,” or weighing benefits and costs in your specific context. What’s important, though, is to look at the whole picture. For example, accounting expense is naturally an important piece of the cost, but don’t overlook administrative or communication complexity. And differences in accounting cost should be weighed against the tradeoff, where less expensive plans are usually less attractive to employees as well.
Ultimately, the value that employees perceive is what drives participation and engagement. This includes the dollars they receive, but also their understanding of the plan and the rewards it can offer.
Know your employees and culture. In some industries and geographies—like Intel’s, as a West Coast semiconductor company—an ESPP is expected. In others, the concept may be new to employees and require much more education. We’re very interested in working with companies in industries where ESPPs are less common to explore whether they can unlock outsized retention benefits at a modest cost.
When it comes to plan communications, traditional enrollment notifications are just the beginning. Ideas range from brochures and webinars to splashing enrollment and purchase statistics on the intranet site and breakroom TVs and a roadshow to major company sites. But once an ESPP is established, employees become its best salespeople.
Finally, always model alternative designs and scenarios to ground decision-making in data. For example, more lucrative plans increase accounting cost, but also open up a wide and uncapped range of employee benefit. It’s important to model different possibilities to avoid a surprise outcome later.
Get your copy of the presentation here.
One Size Doesn’t Fit All: Case Studies in CEO Pay Ratio
This session featured David Outlaw along with Wells Miller and Charlene Lake (Harley-Davidson). While CEO pay ratio might not be anybody’s favorite topic, on this occasion it turned out to be a timely one that elicited lively audience reactions.
First up was a discussion about what has happened so far this year. In February, there was the executive order regarding financial regulations. Then there was the reopened SEC comment period (and its results that may have surprised the administration), followed by the CHOICE Act 2.0 under debate in Congress. The next step will be for the Treasury secretary to report back to the president in June, per the original executive order.
What will ultimately happen with the rule? No one knows. While the administration is likely not a big fan of CEO pay ratio requirements, that doesn’t mean delay or repeal is imminent. There are still procedural hurdles to cross, including a fourth SEC commissioner (and the third Republican) being nominated, confirmed, and sworn in. In addition, lawsuits or judicial review can block any changes to existing rules. Finally, there’s a question of priority: With limited time and political capital, it isn’t clear that CEO pay ratio is at the top of what’s already a long wish list. Pragmatically, most companies are taking a “Goldilocks” approach of continuing reasonable steps toward compliance this year to avoid being caught off-guard next year.
Companies face a number of disclosure-related questions. For instance, what counts as an “employee” for this rule? How should you handle missing employee data? How should messaging change for shareholders, media, employees, and unions?
Usually the answer involves at least one of three avenues. First is to use the rule’s flexibility to your advantage, whether it’s the timing of determining your population or the choice of a compensation measure. Second is to send your desired message in the right way for the stakeholders whose concerns you’re addressing, which may differ among employees, shareholders, and the media. And third, consider the supplemental analysis and disclosures that help tell your story best, slicing or adjusting the data for a more meaningful comparison.
Above all, be prepared and know what to expect. Perform a dry-run calculation this year to know your data sources, your calculation approach, and your resulting median pay and pay ratio. With those answers under your belt, you can keep the board and management in front of potential issues.
Get your copy of the presentation here.
Canary in the Coal Mine: Peer Group Selection and Executive Compensation Benchmarking Data Sources Are Critical
Putting together a benchmarking peer list is an exercise in quantitative and qualitative analysis. This panel—moderated by Robert Lee (Equilar) and featuring Robin Bernstein (Premier), Janet Hunt (CSRA), and Maria Norton (Hibbett Sports)—explored the factors that go into a robust peer list.
The quantitative factors that go into selecting a peer list include the obvious, like screening by GICS code, market cap, and revenue. But stopping there is stopping woefully short of the ideal, considering companies’ objections to the comparison groups that ISS assigns.
Part of the answer is a more refined quantitative approach. One is to examine the connections among companies’ disclosed peers. Analyzing the strength of these connections—such as companies disclosing one another directly, having many disclosed peers in common, and appearing together in other companies’ disclosed lists—can provide important insight.
The other part of the answer is a thoughtful qualitative analysis. Some factors to consider for a peer list include the specific business model within the industry, peers’ geography, and the companies they compete with for management talent. As for a size to target, most companies disclose between 11 and 20 peers, though some have more than 50.
The takeaway? Thoughtfully balance all of the competing factors. Almost no one has a dozen or more pure-play competitors of the same size. Arriving at the right mix will always involve some give and take.
Beyond Pretty Pictures: Influencing and Understanding With Data Visualization
One of the major trends we’ve seen so far in 2017 is data visualization, which can drastically improve the effectiveness of proxy statements, LTIP brochures, and even internal presentations. In this jam-packed session led by Bryan Briscoe (Marriott) and Paul Reiman (Commvault), attendees learned the dos and don’ts of charts, scatter plots, and other data visuals.
At the top of the don’ts list? Distracting or unintuitive charts. This includes obnoxious color schemes, the use of 3D, cluttered labels and legends, and the use of too many axes, among other things. Charts with any of these features can actually be counterproductive for helping audiences understand. As a rule of thumb, a chart that takes more than five seconds to digest and understand has room for improvement.
To create better, more informative charts, start thinking like a designer, with the following “Four As” principles in mind:
“Affordances,” or the aspects inherent to design that make it obvious how something is used (e.g., a knob is for turning, a button is for pushing). When sufficient affordances are present, good design fades into the background and you don’t even notice it. To improve the affordances in your own charts, highlight what’s important, eliminate unnecessary or distracting data, and create a clear visual hierarchy of information.
“Accessibility,” or the notion that designs should be usable by people of diverse abilities and backgrounds. For accessibility, don’t overcomplicate things, use straightforward text, be careful of reds and greens (as a kindness to the colorblind), and keep it clean without omitting key information like axis titles.
“Aesthetics,” or what charts need to look good. Studies have shown that more aesthetic designs are easier to use. For stronger chart aesthetics, be smart with color, pay attention to alignment, and take advantage of white space.
“Acceptance,” or the idea that in order for a chart to be effective, it must be accepted by its intended audience. For greater acceptance, articulate the benefits of the new approach versus the old approach. In addition, show the side-by-side comparison, provide multiple options, and make sure that influential members of the team are on board so that others may follow.
By following these four principles, you’ll be well on your way to creating better and more informative data visuals.
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