One would surmise that the recent Dodd-Frank legislation, coupled with increased investor scrutiny of board behavior and effectiveness, would have at least some impact on the board of director selection process, i.e., filling vacant director slots, at least in part, by those with experience in executive compensation. But is this the case?

In an effort to better understand changes in the board selection process since Dodd-Frank, Farient senior vice president Gary Hourihan recently sat down with Joe Griesedieck , vice chairman of Korn/Ferry International, to talk about trends in director selection.

In his role with Korn/Ferry, Joe works across multiple industries and has completed numerous search assignments for c-suite executives and outside directors for both public and private companies. There are few, if any, in the marketplace with better hands-on knowledge of trends in director selection than Joe. I am delighted to have Gary and Joe share their thinking around this issue:

Gary Hourihan: Joe, you spend a lot of your time recruiting board members for Fortune 500 companies. To what extent has recent legislation, such as Dodd-Frank changed the landscape?

Joe Griesedieck: You’ll likely be surprised to hear that recent legislation, such as Dodd-Frank, hasn’t affected the board selection process that much, and certainty not to the extent that Sarbanes-Oxley did in 2002. There are many out there who believe that few things did more to scale back the “fraternal” nature of boards, and add a diversity component, than Sarbanes-Oxley.

Seemingly overnight, board members (and the audit committee in particular) became more directly accountable to shareholders and we saw a decline in the number of qualified people willing (or available) to serve on boards. In contrast, Dodd-Frank has not placed the entire board in the spotlight. While it has created some unwanted attention and a lot more work for compensation committees as they address Say on Pay and prepare for the upcoming provisions around claw backs and pay for performance disclosures, it has not had the ripple effect of Sarbanes-Oxley and has not impacted the supply of qualified directors.

Gary: Board effectiveness seems to be an increasingly important topic for investors and legislators. Has this changed the focus of your board searches in terms of the types of candidates being sought?

Joe: We are not far past the time when boards of directors were a rather homogenous group where collegiality often trumped specific experience or knowledge in the selection process. But, things are slowly changing. For example,  Korn Ferry’s 2011 annual report on board leadership found that in 2010, 81 of the 95 board appointees at Market Cap 100 companies had served on other boards. In addition, 69 of those available appointments went to someone with current or previous CEO experience.

Here are some specific areas where we are seeing changes:

Board members are more involved in company strategy. For the past 20 years we have seen a transition in power moving from management in the 90s, to board members in the early 2000s, to shareholders today. Board members are communicating more frequently with shareholders. As a result, boards are increasingly more engaged in helping to develop company strategy. Companies like American Express, General Electric, Microsoft, and Prudential are even emphasizing how the board is involved in strategy development in the narrative of their most recent annual proxies.

Board Members have more functional experience and industry expertise, and are more diverse than in the past. I have seen an increase in boards looking for people with very specific experience. Recently, one of my clients acquired a mining company and wanted the newest board member to have mining experience. In the past six months, companies like Starbucks, eBay and IAC have invited 20 and 30 year olds to round out their boards and focus on the company’s digital strategy and a younger customer demographic. I am also seeing more requests for supply chain expertise and international experience as companies expand into Brazil, Russia, India and China.  The reality is that boards are incorporating more diverse perspectives which are having a positive impact on corporate governance. Importantly, the candidates for these roles typically are not former board members or CEOs. These changes add up to a shift in future board demographics.

Re-emergence of the professional director (without the previous negative connotations). Notwithstanding what I just noted, I am seeing more retired CEOs sitting on multiple boards and genuinely engaging with each board. They are truly interested in the company, provide great value, and receive tremendous value back from their participation on the board. The re-emergence of the professional director has minimized the number of directors who are “over committed,” which as you know, is a big concern among the proxy advisory firms. This new crop of ex-CEOs is also bringing down the average age of the board.

Gary: Joe, this brings up an important question in terms board diversity. Most of us think of board diversity in terms of adding more women and minorities to boards. How are you defining diversity?

Joe: Someone recently asked me if we were confusing board composition with board diversity. Certainly diversity has a role in board composition, but diversity covers a lot of ground today. In addition to women and minorities, it can include age, functional experience, personal experience, and international expertise, among other things. It’s really about bringing the right people into the boardroom, eliminating “group think,” breaking down the “old boy” network, and managing risk. From my point of view, it’s all about creating and sustaining shareholder value, and that begins with an effective board.

Gary: One last question that I can’t resist asking as a compensation consultant is how big of a part compensation plays in recruiting qualified directors?

Joe: You may find this surprising, but my experience is that good directors are in it much more for the experience and gratification of contributing to company success than for the money. Money never hurts, but it is rarely the deciding factor.

Gary: It’s been great getting your insights today. My takeaway is that boards are indeed evolving for the better in terms of greater strategic involvement and increasing diversity of functional expertise attuned to business needs. While likely influenced somewhat by legislation, these changes appear more related to general pressure on enhancing overall board effectiveness. And, perhaps surprisingly, pay may be less of a factor than many perceive. These are all positives in a world about which many are skeptical. Thanks Joe. I appreciate you spending time with me today.

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Gary Hourihan is a Senior Vice President at Farient Advisors, LLC, an independent executive compensation and performance advisory firm, which helps clients make performance-enhancing and defensible decisions that are in the best interests of their shareholders. He has 35 years of consulting experience focused on compensation, organization, leadership and talent management, with the overall objective of supporting business strategy, value creation and shareholder interests. Prior to joining Farient, Gary Hourihan was founder and Chairman of Korn/Ferry’s Leadership & Talent Consulting Group, co-founder, Chairman, and CEO of SCA Consulting, and a Partner at Booz, Allen & Hamilton. Gary can be contacted at gary.hourihan@farient.com.

Robin A. Ferracone is the Executive Chair of Farient Advisors and author of the book, “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. Click here to sign up for Farient’s electronic newsletter.

In light of the Company’s Compensation Committee agenda for its upcoming meeting, Ron and I wanted to offer our viewpoint regarding the role of external consultants and the sources of value such trusted advisors can bring to the Committee.  While we will be available during the meeting by phone, this memo outlines our beliefs based on our widespread experience working with compensation committees.  Your proposed process of encouraging the Committee to come to agreement on this topic is a commendable objective and ensures that both the Committee and management have a clear understanding on the role of the outside advisor, including who the consultant ultimately reports to and the scope of services provided.

As described below, we believe our involvement adds value in four principal ways, including offering outside technical expertise, providing objective external compensation and performance benchmarking, ensuring clear alignment of total rewards with performance, and facilitating shareholder communication, not necessarily in that order.  Ideally, this external perspective best adds value when we, as the trusted advisor, understand the Company’s business strategy, value creation process, and the opportunity to use rewards that support these outcomes.

Technical Expertise

As an advisor, we provide the Committee with a technical resource that appreciates emerging issues and implications for the Company’s executive compensation programs.  Specifically, we expect to periodically:

- Offer an overview of general trends and creative approaches, such that the Committee understands not just current practices but appreciates where the market for executive compensation is heading.

- Provide technical assistance with complex compensation issues, such as performance-based equity programs, qualified performance-based compensation, stock option expensing, dilution methodologies, and equity incentive valuation.

Competitive Pay and Performance Benchmarking and Program Evaluation

An outside advisor can educate the Committee on the overall compensation market place, and explain variations across industries, thereby creating contextual understanding and ensuring that Committee members have a broad perspective beyond their specific industry background. Specifically, the advisor can:

- Screen and identify relevant peer sets to gain Committee consensus on competitive sets for pay and performance comparisons.

- Assess the executive compensation strategy and program in light of the current environment.

- Provide a balanced and objective assessment of the appropriateness of the executive compensation program relative to the external environment and internal business context.

Pay-for-Performance Alignment

One of the highest return opportunities where we add value is through our examination of the Company’s performance measurement framework and its alignment with expected behaviors and results. As such, we bring the shareholder viewpoint to the table on both the performance side of the equation (i.e., measures and target-setting) as well as the pay side.  Ideally, we help to ensure that measures align with value creation and that goals are set with the proper degree of difficulty to correspond with executive rewards.  As an outcome of this process, we typically:

- Identify key gaps in the current program and directional refinement in programs for the Committee to consider.

- Assist with implementation of any changes agreed to by the Committee and management based on our experience with other clients.

Shareholder Communication

Recently, we have noted a favorable view within the institutional investor community that the Compensation Committee should have access to independent advisors to ensure credible calibration of pay with performance and to deliver independent, objective input to the Committee’s decision-making process.  In particular, we endeavor to safeguard the Company’s Committee from a governance perspective by:

- Helping the Company to “see around the corners” when we see issues emerging on the horizon (e.g., a negative ISS recommendation or the expected shareholder reactions to certain actions or proposals).  For example, if the Company were to adopt employment agreements, we would insist on not only looking at competitive provisions, but also calculating potential liabilities under various scenarios, particularly negative ones like termination for bad performance.

- Supporting effective governance processes through use of executive sessions and other forums that ensure independence of Committee thought on highly sensitive matters.

- Noting where the Company might be challenged regarding its compliance with the spirit of disclosure, accounting, or shareholder approval matters.

For this process to work most effectively, we prefer continuity of the relationship, which means being present at most Committee meetings, even if only participating through a listening role. Obviously, we need not join if the agenda is particularly light and administratively oriented for certain meetings. Ideally, our involvement is best determined through an annual planning meeting of the Committee calendar, which we have suggested with the head of HR and the head of Executive Compensation as an outcome from the next Compensation Committee meeting.

We look forward to the outcome of your discussions of this topic among the Committee members and trust that you find our insights on this topic helpful. If you would like to discuss this topic in advance of, or during your meeting, please do not hesitate to call either of us.

Best regards,

Robin A. Ferracone

Executive Chair, Farient Advisors LLC

cc: Ron Bottano

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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 and click here to sign up for Farient’s electronic newsletter.

As we wind down for the holidays, and put the first year of Dodd-Frank behind us, now is a great time to look forward and backward. I am thrilled to introduce our guest blogger Ken Daly, president and CEO of the National Association of Corporate Directors (NACD), the nation’s largest member-based organization for corporate board directors, Ken is a recognized expert on corporate governance, executive compensation and corporate board transformation.

Ken’s team at NACD, and my company, Farient Advisors, have been working closely over the past year in a number of areas including the development of the NACD Directorship 2011 Guide to Executive Compensation, and most recently the NACD Compensation Committee Chair Advisory Council which includes Fortune 250 compensation committee chairs, investors, regulators and proxy advisors. 

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I am sure that we can all agree that “pay for performance” has become the buzzword for 2011. Compensation committee members who are active with NACD often tell me that their compensation objective is to award “pay for performance.” Of course, as someone who lives and breathes corporate governance, this is music to my ears.

NACD has been preaching pay for performance since our first Blue Ribbon Commission on the topic of executive compensation two decades ago—and repeated with every new edition over the past several years.  After all, directors represent shareholders, who naturally favor performance-based pay. And since investors only make money when the company performs—it stands to reason that they would want the same approach to executive pay.

Clearly shareholders don’t want directors to “pay for failure,” and in 2012 we may see more directors “voted off the island” if they don’t align pay for performance and communicate their pay decisions to investors. And now, with the Securities and Exchange Commission determined to mandate disclosures on “pay for performance” in 2012, the drum beat for performance-based pay is getting louder.

The Traditional Definition of “Pay for Performance”

But not so fast! During the recent holiday season I had a chance to step back from the buzzwords and really think about it. What do we mean by “performance?” Shareholders generally define this as total shareholder return in relation to peer companies—namely the appreciation of stock price over a specific period, plus dividends, as compared to peers. Regulators are most likely to go along with that definition.

Fair enough. Yet an important nuance is missing here. The definition of pay for performance can and should vary by company. Remember, Total Shareholder Return (TSR) cannot be calculated by business unit, it requires the entire company. Also, the period of time chosen may be very short. And this is a backward looking measure. There is no consideration of future potential (unless that is impounded in the stock price, not always the case when it comes to our stock market, driven as it often is by a herd mentality.)

Here too, one size (and one formula) does not fit all. And hence my caveat emptor—a warning to the buyers of executive talent. Promising “pay for performance” to shareholders, or worse yet regulators, without defining the terms can lead to trouble.

Potential Dangers of “Pay for Performance” Determined by Investors

I have witnessed several troubled scenarios over the years involving investor communications. One example includes a company with a highly effective CEO—one who has strong relations with employees, lenders, customers and some key shareholders. The board says they will structure the CEO’s pay based on performance, but the board does not disclose any specific share-based metrics beyond the ones included in its proxy filing.

Behind the scenes, the board has set a number of internal goals that lead to a long-term sustainable company. However, the board does not use a reporting format to disclose these to shareholders or to regulators. In the course of the CEO’s first year the company makes a number of capital investments that have a payback of five years.

In this scenario, the CEO, in the eyes of the board, has performed well, because these investments will benefit the company long-term. However, for the first year of the payback period, the stock price declines, because the market does not appreciate the value of the capital investments; the market sees only a decline in earnings and fears the worst. Because the board had not disclosed and communicated all aspects of pay and performance, investors unfairly accuse the board of paying for failure.

Potential Dangers with “Pay for Performance” Designed by Regulators

I hope I don’t insult anyone’s intelligence if I remind you of the unintended consequences of federal mandates. Need I say 162(m)? Twenty years ago, most CEOs had salaries of well under $1 million per year. Then the Internal Revenue Service, implementing a provision of The Omnibus Budget Reconciliation Act of 1993, created Section 162(m). This new tax code section removed the deductibility of pay for executives unless their pay was approved by an independent compensation committee. Disclosures of the $1 million-plus packages created a demand among CEOs to top that mark, making $1 million the new floor rather than a ceiling.

So the danger with having a pay for performance mandate enshrined into law by the SEC rule is clear. The SEC will define what performance means and boards will try to adhere to it. If they had more stringent or comprehensive standards for measuring performance these could get lost in the rush to have “pay for performance” designed by Congress. Probably not the best long-term solution!

Six Steps to Redefine “Pay for Performance”

I can’t take credit for all of these insights. I have come to them from serious reflection grounded in extensive dialogue with board leaders, as well as deep primary and secondary research. By dialogue, I’m referring to the deliberations that led to the 2010 Report of the NACD Blue Ribbon Commission on Performance Metrics, co-chaired by John Dillon and William White. In this report, stakeholders and thought leaders agree that directors need to take six measurable steps that go far beyond the simplistic cry for aligning “pay for performance.” These steps include:

1. Understand and agree on the company’s key performance metrics. These key metrics, set for both the enterprise as a whole and for major business units, should be used to track progress.

2. Establish company performance metrics to cascade throughout the entire enterprise. The board should ensure that management has used the metrics to establish more robust and detailed metrics at lower levels.

3. Track company performance against metrics on an ongoing basis. Metrics need to be set annually and monitored over time.

4. Establish consistent and appropriate executive performance metrics. These measures should be used not only for compensation of top officers, but also for managers throughout the organization.

5. Reward executives based upon performance as measured by appropriate metrics. Determine compensation payments based upon an assessment of performance, including consideration of risk, for top officers and other levels of management.

6. Communicate with shareholders regarding how the company has paid for performance. Use clear language to convey the reasons and results of pay.

As you can see, these steps use well-defined metrics that are defensible and encourage ongoing communications between shareholders and directors. At the end of the day, the best board/shareholder relationships avoid any hidden dangers in the dialogue. This relationship is evolving and will continue to benefit from disclosure, transparency, and clarity. As we wind down the most interesting year in proxy season history, fasten your seatbelts—2012 promises to hold many surprises in terms of who stays and who goes.

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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 and click here to sign up for Farient’s electronic newsletter.

I hope you all had a nice Thanksgiving weekend.  Just before the weekend, one of our tech clients commented on the obvious misstep by Zynga, the hot video game maker of Farmville, Mafia Wars and other popular games, in threatening to recoup restricted stock from certain employees, lest they face dismissal.

If you are still catching up on your reading, this bit of news was first uncovered by The Wall Street Journal in an article published on November 10, 2011 titled, “Zynga Leans on Some Workers to Surrender Pre IPO Shares.”  In the competitive market for talent, it was unbelievable to my client how a company could withstand the negative PR and fallout from such a breach of trust.

This situation raises a number of questions:

• How did Zynga get here?
• What other alternatives could it have considered?
• What is likely to be the fallout from this situation?
• What should Zynga do now?

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These questions look like they are straight out of a Harvard Business School case study.

I have no personal knowledge of this situation, but one doesn’t need to be an executive compensation expert to see that the company likely found itself between the proverbial rock and hard place through a combination of poor planning and lack of clarity around corporate values.  In my previous column “Executive Compensation Before and After the IPO” that I co-authored with Ron Bottano, a VP at Farient, I outlined ten compensation strategies for transitioning through an IPO.  One strategy that Zynga might have benefitted from was:

“Consider pay structures to be your friend – High-growth IPO companies often eschew anything that is perceived to constrain creativity.  But establishing a pay structure (i.e., setting salary ranges, target bonus opportunities as a percentage of salary, and equity grant ranges) is one of the keys to scaling the business.  If there is no structure, then everything is an ad-hoc negotiation, which is sure to lead to pay inequities (and discontent).” [Italics added for emphasis.]

One of the first things that any of us do at Farient in assisting very early stage clients is to create a spreadsheet that shows all of the positions by level that the client has now and likely will have in the foreseeable future.  It also lays out the equity that likely will be granted to each person in that position or level, as well as the anticipated dilution of each person’s equity stake through progressive rounds of financing up to and through the IPO.  That way, the client can effectively manage its equity spend during the heavy phases of growth and recruiting, and avoid the issues associated with ad-hoc decisions on compensation.  These issues include:

• Granting too much equity, causing a shortage of equity when it is most needed and/or causing excessive dilution
• Severe “inequity” in the equity allocations, i.e., inappropriate differences in how much equity each person has
• Providing too much equity to those who are not making the contributions that they were expected to make
• Not forecasting the relative cost of equity and various equity vehicles, particularly in choosing between restricted stock and stock options for employees at different levels in the company
• Giving equity where it is not needed for competitive or recruitment purposes, and/or granting equity to those who don’t really value it relative to its cost (usually those at lower levels in the organization)

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In addition, we think long and hard about the type of equity that our clients are granting.  If they are granting options, then shorter (e.g., seven year) terms, for example, might be appropriate to allow the client to refresh the pool.

As for the second question – “Could Zynga have considered other alternatives?” – there are almost always other alternatives.  It would seem that those responsible for the mistake, i.e., top management and the board, should have held themselves accountable.  Could top management and the board have sold a portion of its equity back to the company, which in turn, could have been used for the incentive pool?  Could the company have bought out the unvested equity of certain individuals and then reissued this equity to those who most needed it?  Could the company go public with a higher than normal equity pool, and promise to carefully manage its equity spend going forward?

As for my third question – “What is the likely fallout?” – we’ve already seen a glimpse of it.  First, there is the reputational damage from negative PR.  Then there’s the trust issue that Zynga likely has created.  Third, employee retention may be an issue, at least following the IPO after the big gains are realized (particularly when stock vesting allows employees to cash-out upon the occurrence of a qualifying liquidity event, as in the case of the Zynga IPO).  Fourth, employees may start asking for shorter vesting on future equity grants, or more short-term cash in their pay mix.  Fifth, there are likely to be legal issues.  And lastly, all of these negatives may create a potential drag on the company’s valuation when it goes public.  After all, a company’s value is comprised of both its tangible and intangible assets.

So, what should Zynga do now?  It could stay the course, hoping that a wildly successful IPO will cure all evils.  Alternatively, it also could reverse course, make an apology, and implement one or more of the alternatives discussed above.  Second, following its IPO, Zynga may want to heed another piece of advice that was in my previous column:

“Plan for declining burn rates and overhang - A burn rate is the percentage of shares that a company uses annually for incentive grants.  Overhang is the percentage of shares that are outstanding and available for incentives.  The fact of the matter is that both burn rates and overhang are higher for pre-IPO than post-IPO companies.  Overhang comes down as employees exercise their options and take gains off the table following the IPO.  So, IPO companies need to carefully budget their equity usage and manage to a declining burn rate and overhang over time.”

Third, Zynga should think about its corporate values, and if it hasn’t already done so, codify its values into a cogent set of statements that employees help craft and commit to live by.  And fourth, Zynga should ensure that it has a highly capable compensation committee of the board, experienced in all matters of compensation.

As for shareholders, they will want to scrutinize Zynga’s prospectus for the IPO to ensure that it has a very transparent and cogent plan for managing its incentive equity pool and employee engagement going forward.  After all, the “name of the game” going forward for Zynga will need to be “TrustVille.”.

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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 and click here to sign up for Farient’s electronic newsletter.

It’s been hard to miss the unfolding drama at Hewlett-Packard (HP) over the past few years, from the eavesdropping incident among board members, to Mark Hurd’s alleged improprieties, to the recent dismissal of Leo Apotheker for obvious missteps. As the Dodd-Frank Act became reality in 2010, HP was one of the first companies to receive a majority “no” say on pay vote, due largely to the lucrative sign-on and “pay for failure” severance packages offered to its previous three CEOs, which by our estimates, topped $100 million.

Just over one month ago, Meg Whitman signed on as HP’s new president and CEO, while Ray Lane signed on as the executive chairman of the board, with both being paid for performance in their new roles. So, I asked myself, “Do their pay packages reflect HP as a ‘learning’ organization?”

To answer this question, we first need to review the pay packages themselves. In this regard, Meg Whitman received:

- $1 salary

- $2.4 million target bonus, with $6.0 million maximum bonus

- 1.9 million stock options that carry an 8-year term and a $23.59 exercise price, and vest upon meeting the following conditions:

• 300,000 that vest ratably over 3 years contingent upon Whitman’s continued employment
• 800,000 that vest upon one year of service and achieving a closing stock price of 120 percent of the option exercise price (i.e., $28.31) for 20 consecutive trading days
• 800,000 that vest upon two years of service and achieving a closing stock price of 140 percent of the option exercise price (i.e., $33.03) for 20 consecutive trading days

- A severance benefit equal to 1.5 times the sum of base salary and the average actual bonus for the preceding three years, upon involuntary termination without cause

By my calculation, the target value of this total direct compensation package sums to approximately $16.5 million.

In addition, Ray Lane received:

- No salary

- No bonus

- 1 million stock options that carry an 8-year term and a $23.59 exercise price, and vest upon meeting the following conditions:

• 200,000 that vest ratably over 3 years contingent upon Lane’s continued employment
• 400,000 that vest upon one year of service and achieving a closing stock price of 120 percent of the option exercise price for 20 consecutive trading days
• 400,000 that vest upon two years of service and achieving a closing stock price of 140 percent of the option exercise price for 20 consecutive trading days

- No severance

By my calculation, Lane’s package is worth approximately $7.5 million in target grant value, so the value of the two executives combined is about $24 million.

So, is this a good deal for shareholders? In my view, the answer is a “qualified yes.” In fact, there is good news for shareholders about this pay package. The $16.5 million target, or expected value (i.e., neutralized for performance), for Whitman is at the low end of a competitive range. The annualized competitive total direct compensation (i.e., salary, bonus and the target value of long-term incentives) for a CEO of a tech company of HP’s size (about $125 billion) is easily about $20 million. And they brought Whitman on with no sign-ons, buy-outs, relocation allowances, etc.

One could argue that the HP executive chair role, while not a freebie, has been thrown into the mix for a rather modest premium. In addition, both Whitman and Lane’s pay package pay out only if performance materializes. Granted, Whitman and Lane received their options at practically a 5-year low in the stock price (see Exhibit 1). However, the stock price needs to appreciate to the low to mid $30s in order for Whitman to earn her target pay package of $16.5 million, assuming a target $2.4 million bonus award also is earned. And the stock price would need to appreciate to the mid to high $30s in order for her to earn two times her target award (i.e., $33 million), assuming a maximum $6.0 million bonus award. So, it is clear that Whitman (and Lane for that matter) will win only if shareholders win.

But here are the qualifiers. First, Whitman was given a highly leveraged pay package, meaning that once the options vest, her award levels will increase significantly with only modest gains in performance.  It could be argued that Whitman and Lane’s highly leveraged deal could cause them to take undue risks. However, in both cases, Whitman and Lane have not taken on these roles for the money. So, I think the risk argument all but goes away in this specific instance.

Second, a modest uplift in secular stock prices could drive a significant part of the compensation gain. At the time of this writing, HP’s stock price was about $28, up almost 20 percent from the price at the time of the grant, due largely to an uptick in the secular stock market.

Finally, shareholders will need to keep an eye on what comes next. If Whitman and Lane are successful in turning around HP, I would argue that next year’s package for Whitman should be rather straightforward, i.e., in line with competitive norms, could possibly include a salary, and would be consistent in format with the compensation plans offered to other HP executives.

I would also expect that Lane would not receive incremental compensation for his role because, if it is done right, this role should eventually transition from his executive to a more normal non-executive chairman role. In addition, shareholders will want to make sure that HP does not make cash or equity awards in the future to offset poor stock price performance. This means that HP would not make special awards, retention awards, or discretionary awards, nor would it offer lucrative perks, nor would it increase the severance multiples. In other words, it would work within the “four corners of the incentive plans.”

So, there you have it. Shareholders should give HP high marks for signing on two of the most talented executives in Silicon Valley. As of right now, the parties involved are set up for a rather leveraged win-win. But stay tuned. Future actions are the ones that will tell us whether experience was really the best teacher at HP.

(Click image to enlarge).

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Thank you to my colleagues Dan Mumenthaler, Rob James and Randi Caplan who provided research assistance 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 and click here to sign up for Farient’s electronic newsletter.

Thanks to my Farient colleague Ron Bottano who co-wrote this blog.

What a difference a year makes. Since last spring we have seen the IPO market go from “frothy” to flat.  High-fliers like LinkedIn, Pandora, Zillow and HomeAway had valuations that ranged from 5 to 15x projected revenue and defied gravity.  On the heels of these recent IPOs, the financial press was filled with news about other eagerly-anticipated offerings from such companies as Groupon, Zynga, Kayak, and LivingSocial.

All of this excitement had created a rush to go public, reminiscent of the dot.com era.  But, market volatility made this excitement short-lived. The Dow lost more than 2,000 points from late July through mid-August and by the end of the summer 15 companies had postponed their planned IPOs.

As a compensation consultant for more than 30 years, I have experienced the ups and downs of the IPO market and its impact on executive compensation. As the IPO market regains steam and public capital is raised— that capital must be profitably deployed.  While sometimes described as an “exit,” an IPO cannot be viewed as such by the management team who must execute the strategy to support the lofty expectations embedded in the company’s stock price.  To sustain soaring growth and prove out their business models, how should companies plow capital into exceptional talent who can lead and scale the sales, marketing, product development, and operations functions?

Compensate the talent—It’s easy to think that the most significant post-IPO challenge will be handling the volume of new hire offers.  But the fact is that there will be other more subtle issues that the Compensation Committee and Board will need to anticipate.  For example, in one recent IPO situation, the CEO expected to be “topped up” with stock options in order to preserve the same “ownership” percentage that he had prior to the IPO.  Was this claim a shrewd negotiating ploy, or an innocent misconception?  Either way, the Compensation Committee had to explain to the CEO (over a series of conversations) that as with most IPOs, not only would executives not be “topped up”, but also that dilution could be expected to decline in the years following the IPO.

 Recognize the “haves” and “have nots”—In almost every IPO situation, there’s also the matter of the “haves” (i.e., those who got rich on the IPO) and the “have-nots” (i.e., those who came into the organization after the IPO).   Prior to the IPO, the Compensation Committee may better “equalize” certain people by surgically granting pre-IPO equity.  But after the IPO, there are likely to be diverging wealth accumulation opportunities.  I have found that the best thing for the Compensation Committee to do is to just play it straight and let people know that it’s not realistic to think that there will be parity in executive wealth.  Why?  Because the risk wasn’t the same either.

 Focus on what people can expect—The Compensation Committee is better off focusing on what people can expect.  They can expect that the company will treat people fairly relative to the market and relative to each other in salary, annual bonus, and annual equity grants going forward.  Moreover, they can expect that there will still be very attractive upside opportunities as the company grows and realizes its potential.

LinkedIn is a good case in point.  For the two years prior to the IPO, the top executives received no salary increases, with salaries varying by only $25,000 from the CEO to the top four officers.  Instead, LinkedIn relied primarily on option grants to motivate and recruit its executive team.  Post-IPO, salaries increased by 25 percent to 90 percent, with a more competitive cash pay structure that differentiates by executive role.  Moreover, equity grants are likely to become an annual rather than episodic event, at least for those not receiving initial new hire grants.

Retain your newly rich people— Another issue that is likely to come up is around retaining those individuals who are wealthy enough to retire and “go to the beach,” or who are ready to jump ship for the next “big hit” when the next sexy IPO comes along.  In this case, it is incumbent upon the Compensation Committee to, in effect, change the conversation . . . from the “big hit” to how the executive’s creativity and imagination will be used in the next exciting role, and how there is plenty of upside still ahead.

Plan to justify incentive awards— Compensation Committees can expect that public shareholders will demand accountability on how performance will be measured in order to justify incentive awards.  The public offerings from earlier this year showcase this discipline, with companies shifting from completely discretionary pre-IPO cash bonuses to a post-IPO bonus structure that rewards specific financial and commercial targets (such as registered members, active accounts, revenue, and EBITDA margin) to partially discretionary incentives (say 50 percent quantitative/50 percent qualitative).

For example, LinkedIn ties 50 percent of an executive’s bonus to commercial and financial objectives, and the other 50 percent to individual performance.  In designing bonus plans, Committees continue to retain flexible discretion in post-IPO bonus plans to accommodate the evolutionary nature of their business models.  Such discretion is acceptable to public shareholders under the condition that the Compensation Committee clearly explains the business factors that were considered in applying such discretion.

I think we can all agree that IPOs can be a terrific means to provide growth capital, and to recognize those who helped build the value of the enterprise.  Nevertheless, there are challenges in the aftermath of the IPO.  With the benefit of foresight, good compensation planning, and straightforward communications, expectations can be successfully managed for the benefit of the shareholders and the executives and employees alike.

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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.

In December 2010, I launched the “Executive Pay Watch” blog with the post “What Investor’s Want in the Age of Dodd Frank.” Over the past year, my colleagues at Farient Advisors and I have spent a lot of time with investors to better understand what they want from the companies in their investment portfolios.

In late May, Farient was commissioned by the Council of Institutional Investors (CII) to research and analyze investor motivations to vote against “say on pay” at companies where the proposal failed to receive majority support at the 2011 annual meetings. In this inaugural year of say on pay, investors had a voice in how top executives are paid. The research highlights how investors used this voice in making very thoughtful decisions as they exercised their say on pay votes.

Yesterday, at CII’s 2011 Fall meeting in Boston, my colleague Dayna Harris and I delivered the findings of our research: “Say on Pay: Identifying Investor Concerns.” The research draws on interviews with investors on why they collectively voted against the 37 companies whose pay plans fell short of majority support between January 1 and July 1, 2011.

Some highlights from the research include:

• Investors voted against executive compensation for four primary reasons: pay for performance disconnect (92 percent); poor pay practices (57 percent); poor disclosure (35 percent); and unreasonably or inappropriately high compensation (16 percent).

• Investors evaluated performance and pay over multiple years.

• Investors focused their time on in-depth analysis of pay at “outlier” companies, i.e., those with the largest disconnect between pay and performance and/or those with the most egregious pay practices.

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But don’t be fooled by the 2 percent failure rate (i.e., the percentage of companies that did not win majority support) on say on pay.  By and large, investors say that they applied a “light touch” in 2011, and believe that corporate America still has some work to do on executive compensation.

I encourage you to follow the link to the full report on the Council of Institutional Investors’ website.  It lets you hear their opinion – straight from the investor’s mouth.

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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.

On Aug. 24, Apple, Inc. announced that Steve Jobs, its iconic co-founder, was resigning from his CEO role and assuming the chairmanship.  Tim Cook, Apple’s head of operations, would become the new CEO.  Investors took the news in stride, with a slight dip in stock price followed by a rebound.

For those of us who think that this change might have been done in haste at a time when Apple’s hand was forced due to Jobs’ health, think again.  To gain insight into Apple’s succession process, my firm, Farient Advisors, analyzed Apple’s history since it went public in 1980, and plotted the company’s market capitalization, certain noteworthy events, and of course, occupants of the top jobs. Please see the accompanying exhibit below (click to enlarge).

For many of us who grew up with Apple, we feel as though the company’s history is indelibly etched in our minds.  After all, many of us learned how to use a computer on an Apple.  We lived through the drama surrounding Apple for years, played out in the media by the corporate paparazzi, as it tried to find its raison d’etre.  But the timetable I constructed refreshed my memory.  It reminded me that neither Jobs nor Wozniak, the company’s co-founders, was CEO when the company went public.  It further reminded me that within a few years of Apple’s IPO, John Sculley was appointed as CEO in an attempt to “professionalize” management, driving Jobs out of the company.  These were not Apple’s glory days, as the company muddled along with a relatively flat market capitalization for more than a decade.  But then, in 1997, Apple purchased Jobs’ company, Next, and brought him back from “exile” as interim CEO.

One of Jobs’ first acts as CEO was to hire Tim Cook as chief of Apple’s worldwide operations, setting the stage for the company’s spectacular turnaround.  Jobs and Cook proceeded to forge a strong partnership, and rescued the company from its death spiral, which took it from $11 billion in revenue in 1995 down to less than $6 billion in 1998.  Jobs reinvented the company by practically disrupting the entire music industry and innovating wildly successful products.  Meanwhile, Cook made the operations sing by streamlining facilities and the supply chain, all of which dramatically increased margins.  Cook also had a test run as CEO in 2009 and then again in 2011 when Jobs was managing his health situation.  Under their leadership, the company went from its nadir to a remarkable $100 billion today.

So, the question is, “Did Apple do a good job of succession planning?”  Judging from the result, I think the answer is, “yes,” although the process may not have been too pretty along the way.  Let’s look at the facts.  Cook was an adjunct to Jobs for the better part of a dozen years, and he was test driven as CEO at least twice.  In addition, Jobs will serve in the chairman role going forward, allowing the company to capitalize on his formidable genius and vision.  So, it is no wonder that this transition turned out to be a yawner from an investor perspective.

Many also are asking whether Jobs can really be replaced.  The answer is, “Of course not.”  He is one of a kind.  But the better question is, “Does the current company, with $100 billion revenue, really need the same leadership as the company that grew from $10 billion to $100 billion?”  And once again, the answer is, “Of course not.”  The company will need more of Cook’s influencing and operating skills to bring the organization forward.

So, ultimately, the question is, “Is Cook the right successor?”  Time will tell, but the question underscores once again that this really is a game of succession, and not replacement.

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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