All posts in Blog Current

This article originally appeared on Robin A. Ferracone’s “Executive Pay Watch” blog on Forbes.com.

It’s hard to believe that it’s been more than six months since I launched my Executive Pay Watch blog on Forbes.com. Since Dodd-Frank became a reality last July, I have dubbed 2011 as “the year of the investor.”  The first blog I wrote in December 2010 focused on ‘What Investors Want in the Age of Dodd-Frank.’ Since that time, my colleagues at Farient Advisors and I have continued to research the investor perspective and how boards of directors can work more effectively with their investors.

Last week I had an opportunity to present at WorldatWork’s Total Rewards Conference in San Diego, California.  I was joined by Stephen Brown, Director of Corporate Governance and Associate General Counsel for TIAA-CREF.  Judging by the turnout for our session, “Bringing the Investor Perspective into the Boardroom” is a hot topic for compensation professionals.  I had an opportunity to interview Stephen while at the conference and wanted to share some excerpts of that interview on today’s blog.  To listen to the full interview, please click on the screenshot included at the end of the post.

Robin A. Ferracone (RAF): “Stephen, thank you for joining me today. I’ve heard you say on multiple occasions that ‘executive compensation decisions are a window into boardroom.’ Can you please elaborate on what you mean by that?”

Stephen L. Brown (SLB): “Our conviction at TIAA-CREF is that good corporate governance should maintain the appropriate balance between the rights of shareholders — the owners of the corporations — and the needs of the board and management to direct and manage effectively the corporation’s affairs. The executive compensation process, as it is disclosed through the Compensation Discussion and Analysis (CD&A), is an excellent opportunity for shareholders to look at the work of the board and to see how they think about executive compensation.  It is the one place where we really get an insight into their deliberations.  So, we often say that ‘executive compensation decisions provide a window into the boardroom.’

A lot is riding on the compensation committee.  We are advocates of Say on Pay and were advocates long before it became mandatory under Dodd-Frank.  We think executive compensation decisions and policies are a great representation of what goes on in the boardroom, and it tells us how the board is thinking about what’s best for long-term shareholder value creation.”

RAF: “Red flags in executive compensation are often quite obvious.  But can you share with us what ‘yellow flags’ you sometimes see?”

SLB: “Great question.  I can definitely think of a couple of yellow flags.  One is the degree of discretion the committee has in the compensation process.  We believe in discretion.  We believe that the committee should be flexible in looking at different issues.  But the more discretion the committee has over executive compensation, the more explaining it needs to do.  If a compensation committee has a great deal of discretion, then the committee needs to explain how it uses that discretion every time it is being used.

Another yellow flag for us is the generous use of various rewards mechanisms, like stock options or other mechanisms, that have a tendency to provide a great deal of upside that may not be reflective of the marginal input of the actual executive.  We are not against options per se.  We think options can be used to appropriately reward executives.  But we are on the lookout for excessive use of these types of pay mechanisms and too much leverage.  Here, a great explanation, i.e., disclosure, is really important to investors buying into the program.  In fact, disclosure really is the answer to many different things in executive compensation.  I can’t say it enough . . . it’s about disclosure, disclosure, disclosure.”

RAF: “We’ve talked about discretion and we’ve talked about vehicles like options that are highly leveraged that could be misused, not just used.  What I am getting from you is that there is a delicate balance between managing to ‘shareholder rights’ and letting the board and management do their jobs.  How do you go about ensuring that the appropriate balance exists?”

SLB: “It’s certainly a delicate balance because shareholders should not dictate the specifics of compensation.  We believe that shareholders should be very respectful about the type of discretion and flexibility that a board has so that the board can do its job for that specific company.  That said, we like to follow that phrase: ‘Trust, but verify.’  We are trusting in the directors to do their oversight job, but we need to verify that they are in fact doing their job.

Again, this goes back to that ‘window into the boardroom’ and reading the CD&A to examine how compensation philosophy is portrayed at a particular company.  It is very important to us to figure out if the directors are indeed doing their oversight job.  We know that Say on Pay was a controversial law when it was passed.  At the end of the day, we’ll see that the overwhelming number of companies will pass their Say on Pay votes.  The small number of ‘no’ votes is reflective of the fact that most companies in the United States are doing a good job in compensation.  The small number of companies who don’t pass will need to figure out why they didn’t pass . . . to figure out what shareholders were thinking when they voted it down.  Say on Pay is a good thing.  We do not want to substitute our judgment for the board’s judgment.  We just want to understand the board’s judgment.  And really, disclosure is the key here.”

RAF: “TIAA-CREF has over $476 billion in assets under management as of the end of 2Q.  What are you doing to publish guidelines and to communicate with companies?  What is your starting point as to what you are looking for so that TIAA-CREF, as a major investor, can help companies respond to these guidelines?”

SLB: “Thank you for mentioning that we have guidelines and that we publish a policy statement on corporate governance.  One of the better things a company can do before speaking with us at TIAA-CREF is to go on line at www.tiaa-cref.org/policystatement and review our executive compensation guidelines within our Policy Statement on Corporate Governance.  Those guidelines are pretty clear and self-explanatory so I’ll simply sum up with the primary themes:

- We believe in granting deference to the board and that the directors are the ones with the most information to make compensation decisions.  We fully understand this and our policy reflects this. That said, as good stewards of our participants’ capital, it is our duty to ensure that the board is employing a compensation program aligned with producing sustainable long-term shareholder value.

- We need to understand how pay is linked to performance and how the compensation program is aligned with shareholder interests.  Thus, disclosure is key.  I can’t say it enough how important disclosure is in this process.

We don’t get overly excited about looking at the raw numbers.  We know that is one of the most alluring parts of the a proxy statement. Most people can’t help but to immediately flip to the summary compensation table to see how much the top five Named Executive Officers have made.  We tend not to do that.  We have a discipline in which we read the pay philosophy first, then look at the numbers.  We revised our policy statement this year, and I am pleased to say that our policies on executive compensation haven’t changed much since our last revisions five years ago.   After carefully considering all that has occurred in the market over the last five years and recent legislation, we were quite confident that we had the correct approach to evaluating compensation. Consequently, we spent most of the revisions streamlining the document making it easier to use. We want everyone who engages with TIAA-CREF to read the document first, and then talk with us.  That’s the best way to start the dialogue.”

RAF: “Stephen, thank you again for joining me in San Diego at the 2011World at Work Total Rewards Conference.  As my colleagues at Farient Advisors and I continue to  bring the investor perspective into the boardroom, it is clear that investors want more communication, disclosure, and a long-term focus from their boards of directors on shareholder value.  As we work our way through the first year of Dodd-Frank, it seems to me that the law is benefitting both directors and investors alike.”

Robin Ferracone from Stern + Associates on Vimeo.

_________

Robin A. Ferracone is the Executive Chair of Farient Advisors LLC, an independent executive compensation and performance advisory firm that 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 robin.ferracone@farient.com.

Stephen L. Brown, Esq. serves as Director of Corporate Governance and Associate General Counsel for TIAA-CREF, a full-service financial services group of companies with over $476 billion in assets under management as of March 31, 2011.  On behalf of the boards of the TIAA-CREF group of companies, Mr. Brown and his colleagues in the Corporate Governance Group work to enhance the governance and social responsibility practices of companies held within TIAA-CREF’s investment portfolios with the objective of increasing shareholder value and improving long-term performance of targeted companies.  Mr. Brown also advises management and the boards of the TIAA-CREF group of companies on internal corporate governance operations.

This article originally appeared on Robin A. Ferracone’s “Executive Pay Watch” blog on Forbes.com.

We all see that ISS has a mind of its own when it comes to peer group selection for assessing the integrity of the relationship between pay and performance.  Just the other day, I had a client that was coming under attack by ISS on its pay for performance test, with ISS claiming that the company was overpaying relative to the peer group that it had independently selected.  This test was then used as the basis for ISS’ Say on Pay recommendation.  But our firm, Farient Advisors, had a different point of view.

We conducted a competitive pay analysis which showed that our client was paying competitively, but against a peer group that we considered to be more relevant than ISS’ peer group.  Admittedly, we all know that companies can commit “peer group abuse,” but in the case of our client, this wasn’t what was going on.  (Anyone who knows Farient, knows that we would not let this happen.) So, who should investors believe?  ISS or the company?

For the past 25 years ISS has been providing proxy research and voting recommendations to shareholders.  As part of their pay for performance analysis, ISS measures a company’s total shareholder return (TSR) for one and three years and compares it to the median TSR of the companies in its four-digit Global Industry Classification Standard group (GICS).  If the company’s one- and three-year TSR falls below median, ISS will focus on the company’s executive compensation practices, with a bullseye appropriately placed on the CEO.

Like most companies that run pay and performance market comparisons, ISS uses a peer group to assess pay for the company in question.  ISS generally determines a peer group by selecting 8 to 12 companies within the same six-digit GICS code that have revenues ranging between 0.5 to 2.0 times the target company’s revenue.  While ISS’ method is understandable considering the mass volume of companies that it needs to analyze, this “one size fits all” approach is not always suitable.

As another case in point, Farient developed a peer group for one of our manufacturing clients in multiple businesses and heavy international exposure.  We identified 15 companies with similar business characteristics to our client for the peer group.  We compared our group to ISS’ peer group and found that only five companies overlapped.  This was because ISS emphasized revenue in its peer selection process and Farient emphasized the company’s business model, including multiple business units, international presence, and similar customer and other characteristics.  We thought taking the business model into account was important to reflect both the strategy of the company as well as the talent and skills needed in the organization.  After size-adjusting the data, we found that the company’s peer group pays approximately 10 percent more than ISS’ group.  This made sense to us given the complexity of our client’s business.

So, where does this leave investors in deciding how to cast their Say on Pay vote?  First, if ISS and the company disagree on the integrity of the pay for performance relationship, and therefore, the Say on Pay vote, then investors will need to sort out why.  The difference between ISS’ and the company’s peer group is a good place to start.  Second, if the ISS and company peer groups differ materially, then the company will need to make a compelling case as to why their group makes more sense than ISS’ group.  Third, if the median size of the company’s peer group differs from the company’s size, then the company will need to show how the company is appropriately size-adjusting the data.  Fourth, investors should expect the company to demonstrate the relationship between the company’s performance and pay.  Farient’s Alignment Model does a good job of this because the model automatically takes company size into account, and also can be applied to any peer group or industry cut.

ISS has proven to be a reliable resource for investors and has changed the standards by which executive pay is assessed.  However, their one-size-fits-all approach to peer groups is probably not as meaningful as a custom cut of peers.  Companies should be prepared to state their case on the matter, and investors should be prepared to listen.

_________

Robin A. Ferracone is the Executive Chair of Farient Advisors LLC, an independent executive compensation and performance advisory firm that 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 robin.ferracone@farient.com.

This article originally appeared on Robin A. Ferracone’s “Executive Pay Watch” blog on Forbes.com.

A question I still get these days is whether performance measures in short- and long-term incentive plans (i.e., STIPs and LTIPs) should differ.  When considering Say on Pay, investors and ISS both consider whether the STIP and LTIP measures are different, and typically give firms higher marks for making distinctions.  This is because risk gurus advocate balance in the measurement system through a diversification of measures as well as time horizons.

Risk is mitigated if there is a combination of: (1) top line measures (to signal growth), (2) bottom line measures (to signal profitability), (3) return on capital measures (to signal the efficient use of capital), and (4) strategic measures (to signal how well the company is positioned for the future).  Further balance is achieved through the diversification of time horizons, with short-term measures differing from long-term measures.  The idea is that such balance will reduce the likelihood that executives will bet the farm and perhaps demonstrate exceptional results in the short-term, only to crash and burn in the longer term.

In general, there are important benefits to diversifying measures and time horizons, better matching the time horizon of decisions with results, and ultimately, rewards.  But using different measures in the short- and long-term plans isn’t necessarily bad.  There may be situations in which the same measures should legitimately be used in both the short- and long-term plans, not to mention the fact that using the same measures is simpler.

I’ve chosen two companies, disguised for confidentiality, to illustrate both ends of this argument.

Take Company A, which is using different STI and LTI measures.  Company A is a multibillion dollar retailer focused on maintaining brand loyalty and customer satisfaction.  In its STIP, the company uses Earnings Before Interest and Taxes (EBIT) and Economic Value Added (EVA).  In its LTIP, Company A uses market share and relative EPS growth, measured over three-year rolling periods.  This differentiated system for the short- and long-term makes sense for the company in that it is measuring profitability, which is a shorter-term proposition, while looking to continuously improve its competitive positioning, which is a longer-term proposition.

As a counterpoint, take Company B, which is using the same STI and LTI measures.  Company B is a capital intensive manufacturing company.  The time horizon of Company B’s investment decisions is long-term.  Company B measures EPS growth and return on capital in both its STIP and LTIP plans.  This makes sense since the measures encourage executives to profitably deploy capital on behalf of shareholders, thus balancing both growth and return.  Moreover, the use of the same goals (i.e., standards of performance that persist year after year) in both plans means that executives can’t “game the system.”  If executives generate excellent growth in one year, the growth standard just becomes more difficult to hit in the next year.  If performance is down, and growth is easier to attain in the next year off of a lower base, then the long-term plan (with 3-year overlapping cycles) ensures that this growth is sustained in order to deliver above target awards.

The point I am making is that conventional wisdom suggests that measures should differ in the STIP and LTIP plans, and the vast majority of companies now do this.  In many cases, this makes sense.  However, in some instances, a good case can be made for using the same measures in both plans.  This is true particularly if these measures are balanced and appropriately tied to the company’s strategy and decision-making processes.  As with most things in life, good judgment trumps the rote application of hard and fast rules when making decisions about short- and long-term incentive measures.

A special thanks to my Farient colleague, Dayna Harris, who helped me think through and write up the issues associated with this blog.  Dayna is a Vice President in our Los Angeles office.

Robin A. Ferracone is the Executive Chair of Farient Advisors LLC, an independent executive compensation and performance advisory firm that 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 robin.ferracone@farient.com.

This article originally appeared on Robin A. Ferracone’s “Executive Pay Watch” blog on Forbes.com.

On April 20, The Boston Globe reported that flight attendants at American Airlines were intending to picket airports around the country to protest the high-flying pay of their top executives. They purportedly wanted to demonstrate their dissatisfaction with over $100 million in compensation to their top executives over the last six years while the flight staff took it in the chin by foregoing over three times that amount in 2003 to help the poorly performing company.  Is this just a negotiating tactic?  Or do the flight attendants have a legitimate complaint?

American’s management seems to think it is the former, responding by saying that management’s pay was largely variable and tied to stock price performance, and that over the past ten years, executives had only been paid about 65 percent of their intended compensation.  Who’s right?

To determine whether American’s management is being paid what it’s worth, I proceeded to answer three more questions:

– How has American’s stock price performed relative to other airlines?

– Has the pay of American’s CEO, Gerard Arpey, been aligned with shareholders’ interests since he came into the CEO role six years ago?  Has American’s management earned its keep?

– What would be the outcome if the flight attendants got their way – i.e., got management to forego increases in variable compensation as performance went up?

To answer the first question, I looked back over the last six years at American’s Total Shareholder Return (TSR), which is stock price appreciation plus dividends reinvested in the stock (“TSR”).  Over this time period,  American’s TSR (on an annualized basis) was -6 percent, compared to a median of -3 percent for the other airlines, including Alaska, Delta, JetBlue, SkyWest, Southwest, United Continental Holdings and US Airways.  This isn’t particularly good performance on anyone’s part, except perhaps Alaska which returned 9 percent over the same time period.

To answer the second question, I looked at American’s Alignment Report to determine whether Mr. Arpey was paid fairly on a performance-adjusted basis over this same time period.  In a word, we found the answer to be “yes.”  Mr. Arpey was paid between $3 and $4 million per year in total direct compensation, including his actual salaries, his actual bonuses (which were $0), and the actual value of the equity incentives he received over this same period.  By our calculation, he actually received roughly half of his target award, or what was intended to be paid had performance been as expected.  Further, the Farient Alignment Report™ shows that these pay levels were fair relative to market norms given American’s size, its industry, and the performance that it delivered.  Despite poor performance, American’s executives are in fact being paid appropriately relative to that performance.

To answer the third question, I am reminded that the executive labor market is competitive.  After all, we live in a free market economy where wages are largely set by the forces of supply and demand.  If management had been overpaid for the job it had done, then flight attendants (and shareholders) could ask for a pay cut (or at least no increases in variable pay) and not be too worried about losing the management team.  But American’s pay has been fair relative to its performance. Pay was low in a period of low performance, and so, pay is higher in a period of good performance.  That’s the way shareholders want it.  If this didn’t happen, then American would not be paying competitively.  And if American did not pay competitively, then it would risk executives flying right out the door.  And if competent executives were to fly out the door, then the company’s performance prospects would be even further diminished.  And if this were the case, then the flight attendants might be permanently grounded.

So, what’s preferable for the flight attendants?  A fair executive pay for performance system?  Or being permanently grounded through layoffs?  If I were a flight attendant, I know which one I would choose.  I would get off the picket line and focus on enjoying my work.

_________________________

Thanks to my Farient Advisors’ colleague Dayna Harris who provided the research for this blog.

Robin A. Ferracone is the Executive Chair 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 robin.ferracone@farient.com.

This article originally appeared on Robin A. Ferracone’s “Executive Pay Watch” blog on Forbes.com.

For today’s Executive Pay Watch blog, I have asked Dan Walter, President and CEO of Performensation and founder of Equity Compensation Experts to weigh in on pay transparency.

Executive compensation is justifiably complex. In fact, the total compensation for nearly everyone in this country is difficult to communicate. Those at the highest corporate levels generally have pay structures that reflect the complexity of their company. Regardless of the intricacy of executive pay programs, it is still a very reasonable request to ask for pay transparency from these publicly traded firms.

New disclosure rules have taken another step or two up the ladder towards transparency. In fact, the HR Policy Association reports that the average Executive Compensation Disclosure for the 50 largest U.S. public companies has increased 23 percent to 32 pages since 2008. This represents about one-third of their total proxy statement.

Pay transparency is a reasonable concern, but it should be a two way street. Shareholders, employees and politicians want to understand how and why executives are compensated. The new Dodd-Frank provisions have once again increased transparency, but some of the loudest advocates for this are the proxy advisory firms whose rating processes and databases are deemed proprietary.

Not surprisingly, executives and compensation committees want to understand how these third-party evaluators are measuring compensation. Compensation professionals are tasked with making “best-guess” estimates regarding the acceptability of potential compensation proposals. While a trained professional can often get close to the right answer, they never know how well they have done until advisory firms have released their opinions. This process is both inefficient for the company and board of directors and does not truly serve the shareholders.

Measuring executive compensation should be similar to a sport like diving where the voting is a subjective interpretation of a well documented scoring system. In a sport like this, the coaches and athletes (boards and executives) understand the scoring system. They know the potential reward for every move and understand the impact of every risk. Each series of dives is based on an athlete’s ability to maximize return while minimizing risk. Such a system requires execution on the part of the athlete, with the confidence that the only surprise in the individual’s performance is against their peers. The rules are well documented and the judges apply them to the best of their abilities.

Imagine if executive compensation worked this way. The execution is already increasingly more public. Executives at public companies are not diving in a windowless room and then reporting how well they did. It is time for the scoring system to become equally transparent. Everyone should know the rules and how exactly they should be applied. The final analysis will be subject to interpretation and allow for companies to be both creative and individual within a framework these both sides understand.

In writing this post, I found an April 19 article from Stanford Professors, David Larcker and Brian Tayan discussing whether the voting recommendations from Institutional Shareholder Services (ISS) and other proxy advisory firms actually create shareholder value. They found that examining the impact of the recommendations was difficult because “the algorithms and data are considered proprietary.” This inability to measure effectiveness is the same common complaint against the lack of transparency in executive compensation.

There are tens of thousands of proxies to be reviewed every year. Firms like ISS and Glass-Lewis serve an important service in reviewing the data for all of these firms by providing insight into corporate governance and best practices. In theory, they allow the smaller institutional investors to invest in a broader array of companies with more confidence. It is unlikely that many of these investors would be able to operate, as cost-effectively if they had to staff their own full team of analysts like the very large investors do. The proxy advisory firms help create some consistency in voting, but it is at the price of guesswork on the part of companies.

Firms such as Glass-Lewis and ISS have generally been a positive force on executive compensation over the past decade. As the world of executive compensation evolves, it may be time for them to follow their own guidance and raise the shades on their windows. If transparency works well for executive compensation, it should also be great for those who provide definitive guidance on it.

Guest contributor Dan Walter is based in San Francisco, CA and is the President and CEO of Performensation, an independent compensation consulting firm focused mainly on the needs of companies not in the Fortune 1000. In addition, Mr. Walter is the founder of Equity Compensation Experts, a free networking group.

_________

Robin A. Ferracone is the Executive Chair of Farient Advisors LLC, an independent executive compensation and performance advisory firm that 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 robin.ferracone@farient.com.

This article originally appeared on Robin A. Ferracone’s “Executive Pay Watch” blog on Forbes.com.

In the spirit of Earth Day last Friday, I did some reading on what companies are doing these days to improve environmental sustainability, curious to see whether such programs are finding their way into incentive plans, and whether they are providing tangible results.  So, I asked myself the following questions:

• To what extent are companies incorporating sustainability measures into their incentive plans?
• To what extent are such measures quantifiable and challenging vs. a walk in the park (so to speak)?  Are there good examples of what companies are doing in this regard?
• Is sustainability accretive to the value of businesses that have sustainability measures and rewards?  In other words, we know that sustainability is good for saving our planet, but is it good for shareholder value?.

Well, I didn’t have far to go to find companies that are incorporating some sort of sustainability agenda into their incentive plans.  According to Farient Advisors, approximately 10 percent of the S&P 100 are currently factoring environmental issues into their incentive compensation plans, either as strategic objectives or quantifiable goals.  These companies are employing a broad portfolio of sustainability goals, including the reduction of greenhouse gas emissions, waste management, water conservation, and being a sustainability leader, as indicated by being included in the Dow Jones Sustainability Index, for example.  (For those of you not familiar with the Dow Jones Sustainability Index, it uses “a defined set of criteria to assess the opportunities and risks deriving from economic, environmental, and social developments.”)

To better illustrate the point, I found a number of real life examples on how companies can incorporate sustainability into their incentive plans, three of which are shown below:

Dean Foods: Dean Foods expressly charges board members with governing sustainability.  The Audit Committee oversees corporate social responsibility policies, including those covering sustainability, ethics, compliance, and reputation, while the Compensation Committee evaluates executive officers on the basis of these factors, weighted 40 percent.  The CEO is measured on the basis of instilling a culture of ethical behavior and social responsibility.  The Chief Supply Chain Officer is measured on the basis of saving water, improving energy efficiency, and reducing waste output in the supply chain.  With the aid of such goals, Dean Foods has cut water use by 5.6 percent over the last year, and has reduced greenhouse gas emissions by 6 percent over the last three years.

Xcel Energy: As an energy and utility holding company, Xcel has a significant stake in environmental preservation and marks its commitment to sustainability at the highest level by applying specific quantitative metrics to incentive awards.  In fact, one-third of the CEO’s annual bonus is tied to environmental performance, as measured by renewable energy, emission reduction, energy efficiency, and clean technology.

Environmental sustainability is also taken into account in long-term incentive awards, as 25 percent of restricted stock units granted have a performance-based vesting schedule related to Xcel’s position as a leader in environmental conservation.

Alcoa Inc: Since 1993, Alcoa has published its long-term environmental sustainability goals and progress. Last year, Alcoa took a step forward in its level of commitment by including such goals in its executive annual bonus plan.  With 80 percent of the bonus plan tied to traditional financial metrics, 20 percent is reserved for non-financial goals including safety, diversity, and environmental health, as indicated by reducing CO₂ emissions by 400,000 tons in 2010 (weighted 5 percent).

Many of the companies that incorporate sustainability objectives into their incentive plans report on how these objectives are helping them create value for investors through things like reducing costs, attracting and retaining customers, spurring innovation in the design of new and improved products, enhancing reputational value, and providing a more inspiring place for people to work.

Many investors now make their investment decisions on the basis of corporate social policies, including sustainability.  In addition, others cast their shareholder votes in accordance with shareholder resolutions that support sustainability.  For example, TIAA-CREF, the largest of the institutional investors with over $450 billion in funds under management, states that their policy for Global Climate Change is to “generally support reasonable shareholder resolutions seeking disclosure of greenhouse gas emissions, the impact of climate change on a company’s business activities and products and strategies designed to reduce the company’s long-term impact on the global climate.”

To be sure, the trend toward a focus on sustainability is not a short-term fad or fix.  Corporate social objectives are big ideas that take time.  Diversity, for example, has been a corporate social objective for the last 30 years, and we’re still working on it.  Similarly, sustainability will attract increasing attention over the next several decades.  If your company has not yet addressed the sustainability issue, it might be a good time to start.  After all, it seems as though what’s good for the planet is good for business.

_________

Robin A. Ferracone is the Executive Chair of Farient Advisors LLC, an independent executive compensation and performance advisory firm that 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 robin.ferracone@farient.com.

This article originally appeared on Robin A. Ferracone’s “Executive Pay Watch” blog on Forbes.com.

Dodd-Frank required the SEC to adopt Compensation Committee independence rules that: (1) prohibited the listing of companies on securities exchanges that did not comply with the rules, (2) required all members of the compensation committee to be independent, and (3) required compensation committees to have the authority and funding to engage their own independent consultants, legal counsel, or other advisors and to be responsible for their appointment, compensation, and oversight.  However, Dodd-Frank did not stipulate that the advisors must be independent of the company.  Rather, it required the company to disclose how the Committee would consider factors that would affect the independence of the advisors, and required the SEC to adopt rules identifying those factors, which would include, but not be limited to:

• The advisors’ provision of other services to the company
• The amount of fees paid by the company to the advisor as a percent of total revenue of the advisor
• Conflicts of interest policies and procedures of the advisor
• Other business or personal relationships between the advisor and the Committee
• Ownership of the company’s stock by the advisor.

The SEC’s Interpretation

On March 30, the SEC announced its proposed rules on independence, which interestingly, reflect an almost verbatim application of the Dodd-Frank directives.  The SEC is now inviting comment on the rules, which are to go into effect by July 21, 2011, exactly one year after Dodd-Frank was signed into law.

So, since the SEC asked for comment, I am commenting . . . right here . . . right now.  First of all, the road to good governance was paved with good intentions.  According to Robert J. Jackson, Jr., Associate Professor at Columbia Law School, and deputy special master for TARP Executive Compensation, Dodd-Frank was designed to put more power in the hands of Board Directors.  As such, Dodd-Frank stipulated that the Committee should retain the advisors and judge their independence.  These are good intentions.

But this is where the reality departs from the intent.  In order for Compensation Committee advisors to be “independent” (i.e., with no conflicts of interest), they and their firms must have one final point of accountability, i.e., the Compensation Committee, and not management.  It’s that simple.  The rules should speak to ensuring that the advisors have one master, not two.  This is where four of the five criteria above fall seriously short of the mark.  Let’s examine these four provisions one by one:

• The advisors’ provision of any other services to the company – What the company should really care about is whether the advisory firm is providing any other services that are not services to the Board.  It would not be a conflict if the company were providing other services to the Board, but the rule is silent on this point.
• The amount of fees paid by the company to the compensation advisor as a percentage of that person’s total revenue – I can’t understand why this provision even speaks to a conflict.  Even in the extreme, why would there be any conflict or independence issue if an advisor has only one client and is billing 100 percent of his or her fees to the Compensation Committee/Board, and not management?  (Of course, this assumes that the Compensation Committee is running proper interference for the advisor.  If this is not happening, then the advisor may try to please management in order to retain his /her sole source of income, in which case, the company has bigger problems than the advisor’s independence).  Investors should really care about what percentage of the advisory firm’s total billings to that client is for management (similar to my first point above).
• The extent to which the compensation advisor has any business or personal relationships with any member of the Compensation Committee – Here again, what were they thinking?  Shouldn’t investors be worried about whether the advisor has a business or personal relationship with any member of management?  For example, if an advisory firm does work for both Company A and Company B, and the Compensation Committee Chair at Company A is the CEO of Company B, then one might conclude that there is a potential conflict and independence issue at Company B, not Company A.
• Whether the compensation advisor owns any stock in the company – Now, investors want the Board, including “independent” Directors, to own company stock.  Investors also want management to own company stock which simply means that the board, management, and the advisors are all working for the investors.  Now tell me again, why is it a conflict for advisors to own company stock?  This factor makes sense from the standpoint of controlling insider trading on the part of the advisor, but it otherwise muddies the issue at hand..

In the end, this portion of the Dodd-Frank Act was watered down and politically-influenced.  The Act did not require the Compensation Committee to hire independent advisors, only to consider the independence of the advisors.  Further, the factors that it asked be considered are off the mark.  This left the SEC between the proverbial rock and hard place.  The SEC was asked to interpret the Act, but was left little latitude to interpret it reasonably.

A Better Solution

Given the difficult position of the SEC in that it was required to follow the directives of Dodd-Frank, I would have suggested that the SEC have carried out its responsibilities by delineating the following considerations:

• The advisors’ provision of other services to the company, other than other services to the Board.  This would include a description of the services provided, and the fees the advisor’s firm charged to the Company (excluding those charged to the board of the Company) in dollars and as a percentage of total fees charged to the Company
• The amount of fees paid by the company to the advisor as a percentage of total revenue of the advisor (the SEC was stuck with this one)
• Conflicts of interest policies and procedures of the advisor (this is a reasonable criterion and I’d leave it alone)
• Other business or personal relationships between the advisor and the Committee (the SEC was stuck with this part) and other business or personal relationships between the advisor and management
• Ownership of the company’s stock by the advisor.  (The SEC was stuck with this provision as well.  It’s not that ownership is a bad thing to disclose, it just doesn’t address conflicts of interest).

In summary, I agree that there should be a consideration of potential conflicts of interest as they pertain to the Compensation Committee’s advisors.  Conflicts arise primarily in instances where the advisor could have an interest in jacking up executive pay.  Having said that, conflicts of interest and independence are two different concepts.  While we can take a shot at defining the first one, only the Compensation Committee, in knowing the advisor, can determine whether the advisor behaves with true integrity, balance, and impartiality.

__________

Robin A. Ferracone is the Executive Chair of Farient Advisors LLC, an independent executive compensation and performance advisory firm that 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 robin.ferracone@farient.com.

This article originally appeared on Robin A. Ferracone’s “Executive Pay Watch” blog on Forbes.com.

As of March 31, only four companies had garnered a “no” vote on Say on Pay.  However, many feel as though this is just the start of a proxy season in which investors will take no prisoners.  Why?  Because most investors report that the non-binding nature of the Say on Pay vote gives them a “hall pass” to express their discontent, without severe consequences to the Directors or the employees of the company.  No other vote (except Say on Frequency) allows for such a soft touch.

As a result, I feel that we are at the beginning of a proxy season in which we will see a number of “no” votes yet to emerge.  So, I got to thinking “What can we learn from the four companies that received “no” votes?”  These companies include: Jacobs Engineering, Beazer Homes USA, Shuffle Master, and Hewlett-Packard.  While I don’t feel as though we can draw definitive conclusions based on the experience of these four companies, I do see some common themes emerging.

Jacobs Engineering (46% for/54% against): The first company this season to fail its “Say on Pay” advisory vote was Jacobs Engineering.  The primary reason for the negative vote seems directly related to pay for performance issues.  Specifically, target CEO compensation increased almost 50% from the prior year, caused by a first-time grant of restricted stock in a year when the company did not hit its incentive performance targets and the stock price fell 12%.  Furthermore, although Jacobs generally discloses that its bonus pool is funded on the basis of earnings per share, the level of performance needed for various levels of funding is not disclosed.  In addition, only 50% of awards are based on financial performance, with the remaining 50% left to discretion.  The combination of increased pay for decreased performance, and the lack of transparency in the bonus algorithms appear to have left a bad taste in investors’ mouths.

Beazer Homes (46% for/54 % against): The second story is similar to the first.  It’s a tale of pay for non-performance.  Beazer’s CEO received both a cash bonus and an equity award in 2010, neither of which he received in 2009.  This created a large increase in his total direct compensation in a year in which Beazer’s stock price dropped 26%.

Shuffle Master (45% for/55% against): Unlike the previous two examples, it appears as though Shuffle Master’s pay for performance alignment played only a minor part in the vote.  While salaries increased slightly, shareholders saw their stock value increase 20% over the same period.  However, Shuffle Master’s CEO passed away during 2010, and an interim CEO took his place.  The interim CEO has an employment agreement that allows him to voluntarily leave the company and collect lucrative severance benefits following a Change in Control (a so-called “single trigger”).  Shareholders do not like agreements in which the CEO can voluntarily walk and still collect severance payouts.  Also of note is an issue of transparency – there is no mention of an interim CEO appointment in the CD&A until the footnotes in the summary compensation table.

Hewlett-Packard (48% for/50% against): The highest profile company to fail its say on pay vote so far is Hewlett-Packard.  HP had the closest vote of the failed companies with 50% voting against and 48% voting for management.  I view this vote as a soft way for shareholders to express their discontent in both pay for performance and governances matters.  According to the press, the leading factors in the “no” vote were the $12 million cash severance payout that departing CEO Mark Hurd received, a payment shareholders viewed as “pay for failure,” and the magnitude (over $40 MM) of the sign-on package given to Leo Apotheker, HP’s new CEO.  Finally, ISS recommended a vote against both HP’s say on pay proposal in part because of the way in which two of the newly appointed board members were selected.

So, what are the common themes here?  I think there are a few:

1)      Shareholders will penalize the lack of alignment between performance and pay. In three of the four no votes this year, a lack of performance and pay alignment was a leading cause of the “no” vote.

2)      ISS’ recommendations will have an influence, but not a dispositive effect, on the vote.  As a result, companies should take an accounting of whether or not they run afoul of ISS’ list of “egregious” or poor compensation practices, which includes:

• Employment contracts which contain multi-year guarantees for salary increases,  non-performance based bonuses, and equity compensation;
• Overly generous CEO new-hire packages;
• Abnormally large bonus payouts without justifiable performance linkage or disclosure;
• Egregious pensions or perquisites;
• Excessive severance and/or change in control provisions;
• Certain tax reimbursements or gross-ups; and
• Repricing or replacing underwater stock options without prior shareholder approval

In addition, ISS has demonstrated that it will express its displeasure to what it considers to be poor governance provisions that go beyond issues of compensation by recommending a negative Say on Pay vote.

3)      Poor transparency in pay program design and/or communications with shareholders will cause a negative reaction. This reaction could be the result of a substantive program design issue, a disclosure issue, or both.  Shareholders not only prefer pay programs that can be directly tied to performance, but they also want an explanation of what pay decisions the compensation committee made and why.

These companies represent just a few of the early returns.  We will learn much more as the proxy season develops.  But if your company has not yet had its annual meeting, it’s not too late to assess whether your company’s executive compensation programs and practices pass muster based on the criteria above.  And if not, either make changes or address the issues head on with investors.

__________

Robin A. Ferracone is the Executive Chair of Farient Advisors LLC, an independent executive compensation and performance advisory firm that 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 robin.ferracone@farient.com.