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 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 email@example.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.