This article originally appeared on Robin A. Ferracone’s “Executive Pay Watch” blog on Forbes.com.
No sooner has the ink dried on the 2012 proxy season than most compensation committees are thinking about their agendas for the upcoming 2012-2013 compensation planning year (generally running from July 1, 2012 through June 30, 2013 for those companies on a calendar fiscal year).
To get a sense of the major issues affecting a broad cross-section of companies (not just Farient clients), we reached out to many of our Fortune 500 compensation committee contacts to see what is on their minds as they shape their upcoming committee agendas. Interestingly, three clear themes came through in addition to the normal fare (e.g., the obligatory competitive assessment of compensation, monitoring the regulatory environment, etc.), including:
1) Take charge of and continue to refine pay for performance alignment.
2) Think broadly about the committee as an “HR committee,” not only as a “compensation committee.”
3) Determine how to most effectively use the committee’s time..
Take Charge and Continue to Refine Pay for Performance Alignment
Without a doubt, things are evolving in the realm of pay for performance. The fact that investors have identified pay for performance as one of their most significant concerns is no small contributor to the increased focus that it is receiving. According to a one of the directors we interviewed, it used to be that “the HR department would handle inputs on pay and the finance department would handle inputs on performance goals.” However, this process has changed dramatically since the compensation committee is now where it all comes together.
As a result, many committees are still experiencing “pay and performance” as a learning process, and many of the compensation committee chairs with whom we spoke said that while pay for performance alignment has improved, they still regard this as a work in progress (for more on this, see my previous article, “Help Wanted: Compensation Committee Chair”).
For example, key areas of focus for the upcoming compensation planning cycle include:
– Improving the incentive performance measures and their link to value.
– Finding good quantitative measures (besides or in addition to relative total shareholder return) such that the incentive plans can be more effective in focusing executive attention.
– Identifying good, quantifiable strategic measures that link to the strategic plan.
– Better defining metrics, and any unbudgeted adjustments to those metrics (such as the impact of restructuring charges).
– Refining benchmarking and goal-setting processes, and ensuring that even absolute goals are set within a context of relative performance expectations.
In addition to spending time on the pay for performance relationships in incentive plans, committees are also taking the time to ensure that pay and performance are indeed aligned – after performance has happened. They plan to take the time to understand the meaning of tests like Farient’s Alignment™ methodology and ISS’ pay for performance tests, which both provide investors and companies with insights into pay and performance alignment.
Think Broadly About the Committee as an “HR Committee,” Not Only as a “Compensation Committee”
Succession planning is a significant issue for boards, compensation committees and investors alike. Boards are taking CEO evaluation and succession processes seriously, and are formalizing their processes around these functions. Succession planning is viewed as an opportunity to strengthen performance as well as to mitigate risks should something happen to the CEO.
As a result, some compensation committee chairs are adding to their planning agendas a discussion about whether and how to link compensation strategy to succession planning activities, even if succession planning is under the purview of the full board. In doing so, they are planning to attack such questions as:
– Should succession candidates be compensated differently from those who are not seen as successors? If so, how – i.e., should there be pay differentials and/or special retention awards? If so, how much should the differentials be, and what pay vehicles should be used?.
– Should the company have a specific succession planning goal for the CEO?.
– Should the company describe its succession planning process in its proxy?.
As a case in point, CEO compensation is increasingly being tied to specific goals that include succession planning. In fact, one measure we are seeing across numerous companies is the quality of the CEO’s leadership pipeline. CEO pay also is being tied to the development of future leaders through developmental assignments and compensation plans that reward both potential and contribution.
Determine How to Most Effectively Use the Committee’s Time
Board as well as committee agendas have continued to grow. To be truly effective in the upcoming 2012-13 planning cycle, our committee chairs identified judicious time management as something on which they’re going to pay particular attention this year. Interestingly, one item on which our committee chairs reported that they are not interested in spending their time is the social agenda.
One compensation committee chair said, “it is important for committees (and boards in general) to remember that they represent and serve the interests of shareholders – shareholders who almost universally have only a financial interest in the corporation, and who have a social interest only to the extent that those social policies affect their financial interests.”
So much has evolved over the past two years. The one constant is that the job of compensation committees has become more challenging. As many put it, “the compensation committee is the new audit committee.” As a result, shaping a thoughtful agenda for the compensation planning cycle has become more critical than ever. The chairs with whom we spoke appear to be off to a good start.
Robin A. Ferracone is the Chief Executive Officer of Farient Advisors, LLC, an independent executive compensation and performance advisory firm which helps clients make performance-enhancing, defensible decisions that are in the best interests of their shareholders. Robin Ferracone is the author of a recently published book entitled “Fair Pay, Fair Play: Aligning Executive Performance and Pay,” which explores how companies can achieve better performance and pay alignment. Robin can be contacted at email@example.com. Click here to sign up for Farient’s electronic newsletter.