Executive Compensation Alert

Transcription

1 Executive Alert Inside Conference Board Task Force Executive Introduction Guiding Principles Paying for the Right Things The Right Total Avoid Controversial Pay Practices Credible Board Oversight of Executive Dialogue with Shareholders Implementation of Guiding Principles Link to Company Strategy The Right Total Controversial Pay Practices Credible Board Oversight Alert Conference Board Issues Task Force Report on Executive The Conference Board convened a task force in March of 2009 to establish guiding principles for public companies to implement effective executive compensation programs. The task force, together with its advisory group, was composed of a diverse collection of corporate directors, consultants, unions, academics, institutional investors, and other governance experts. The report does not try to impose a set of hard and fast rules. Rather, the guidelines are principles-based and designed so that boards have the flexibility to implement compensation programs that are best suited for a company s business strategy and shareholder needs. The Conference Board report wanted to address the loss of trust investors have in board decisions on executive compensation. In order to restore that trust, direct and convincing action needs to be taken. They hope that adoption of these guidelines will help restore investor confidence in American companies. Guiding Principles Paying for the Right Things First comes the business strategy, then comes the compensation program designed to drive that strategy. As business strategy needs to be focused on creating long-term shareholder value, the incentive portion of executive compensation should be focused on rewarding longterm value creation. Incentive plans need to walk the fine line between not encouraging excessive risk while at the same time not discouraging appropriate risk. The Task Force Report stipulates that this can be accomplished through stock ownership and stock holding plans, and realistic performance targets. The Right Total Benchmarking is critical to ascertaining the appropriate level of compensation for executives. It not only requires careful selection of peer groups, but also aids in determining appropriate target levels of company-specific performance to be considered when setting executive pay. Note, however, companies must realize that benchmarking alone should not be the sole criteria used in deciding the proper level of executive compensation. Transparent Shareholder Communications Copyright 2009 Aon Hewitt 1 October 16, 2009 / Alert

2 Avoid Controversial Pay Practices. In a time of increased scrutiny of executive compensation, companies should avoid practices that are red flags for investors. These practices include: Long-term (or automatically renewed) employment contracts that are spread out over several years and conclude with unrealistic severance benefits; Inappropriate golden parachutes; Tax gross-ups on perquisites or parachute payments; Inappropriate death benefits; Perquisites that are available only to executives and not to other managers; and Repricing or option exchanges that are not value-neutral or shareholder approved. It is possible that a company may encounter a situation where it may be necessary and appropriate to implement one or more of these practices. The company should clearly communicate both the underlying terms of the practice, as well as their justification for implementing. Credible Board Oversight of Executive Essential to restoring trust in the process of setting executive compensation, compensation committees need to be independent, with an appropriate level of experience and knowledge of the company s business. The compensation committee acts as a fiduciary to the company and to its shareholders. To properly accomplish its important work, the committee must be able to control who it engages as key independent advisors. Transparent Communications and Increased Dialogue With Shareholders The primary communication method will be through the compensation discussion and analysis (CD&A) in the company s proxy. It is vital that the information provided be easy to understand by investors. With the likely mandate of an advisory vote on executive pay (a socalled say on pay proposal), efforts must be made to ensure that this does not become a check the box approach. This can be the start of a dialogue, but should not be the end of communication efforts. Copyright 2009 Aon Hewitt 2 October 16, 2009 / Alert

3 Implementing the Guiding Principles Link to Company Strategy Is Critical Because companies vary in their industries, strategies, business models, and stages of development, no one size fits all compensation approach is appropriate. Any compensation program needs the flexibility to accommodate these differences. But one abiding feature is that, within this flexibility, the compensation program must be tied to the company s business strategy. This includes setting the appropriate mix of compensation so that, by design and upon actual payout, performance supports the company s overall business strategy. Other factors include ensuring the use of appropriate performance metrics, performance targets, and performance periods. The relationship between payouts at threshold, target, and maximum is also tied to business strategy, level of difficulty, and appropriate risk. in accord with these principles should adopt clawback programs and, when warranted, recoup payments. The principles also call for companies to have, and disclose, stock ownership and stock holding policies. The Right Total The right compensation for an executive is an affordable package. In determining affordability, companies may look at compensation packages of peer companies, taking into account relevant factors. In benchmarking, companies must take care to select the right peer group, including avoiding cherry picking peers and establishing criteria that is appropriate to internal and external audiences. The right compensation includes targeting the right level of pay. Only in cases where there is ample justification should targets or pay opportunities be set above median pay. Finally, it is important to compare pay to the company s compensation philosophy. Avoid Controversial Pay Practices Every business publication today is rife with stories about executive compensation. Business writers are on alert for certain compensation practices that raise red flags. But there may be justification for a particular company to adopt one or more of these practices. That decision should be in the purview of the board and the compensation committee. Transparent communication is vital in these situations. Severance While employment contracts are not recommended, there may be situations where it is necessary. In any such agreement, severance should not serve to unjustly enrich the executive. Golden parachutes Whatever the justifications, parachute payments should be reasonable and for a limited time. Payments should only be paid subject to a double trigger, that is, both a change in control and an actual executive termination. Gross-Ups Payment of the tax due on perquisites or severance payments, gross-ups, have drawn particular ire among the public. Gross-up payments should be avoided absent special justification. The exception may be for gross-up payments that are available to a broad class of employees. Copyright 2009 Aon Hewitt 3 October 16, 2009 / Alert

4 SERPs Absent special justification, supplemental executive retirement plans (SERPs), other than restoration plans, should be avoided if they provide additional credits for time worked in excess of actual years of service, include equity awards in calculating postretirement benefits, or provide lump-sum payments that are calculated with artificially low discount rates. Other controversial pay practices that generally should be avoided, except in limited circumstances and only then if the board can demonstrate a valid business rationale for each, include above-market return on deferred compensation and option exchange or repricing programs. Credible Board Oversight of Executive While the board bears ultimate responsibility for executive compensation, the compensation committee has special responsibility for the oversight and monitoring of executive compensation. When applying this principle, the compensation committee should think and act like an owner. They should analyze both the costs and benefits of each element of a company s compensation program. While current listing exchanges require compensation committees to be independent, compensation committees should look beyond these legal and regulatory requirements to examine all personal and financial relationships that could be perceived as impairing independence. Members of the compensation committee need to be experienced in the company s business and have an understanding of the various compensation elements (including performance metrics). While members do not have to be experts in the legal, tax, and other compensation design elements, they do need the proficiency to understand the advice from experts in these fields. committee members also need to have access to management who can provide them with necessary information they need to properly fulfill their duties and responsibilities. It is important that the compensation committee be authorized to directly engage its own advisors. Any compensation consultants engaged by the committee need to directly report to the committee. It is the committee s responsibility to determine the advisor s capabilities and independence. The compensation committee should also dialogue with the full board to take advantage of other committees expertise. The committee members should also review other company compensation programs, especially in terms of the risk it represents financially. Copyright 2009 Aon Hewitt 4 October 16, 2009 / Alert

5 Transparent Communications and Increased Dialogue With Shareholders To implement this principle, the board needs to ensure that communication of the company s executive compensation program is delivered in a clear, plain, and effective manner. The board and compensation committee members need to be fully apprised of investor concerns. They need to take steps to address these concerns. The advantages of an effective shareholder dialogue include: Minimize the number of shareholder proposals needed to get the board s attention. Enhance the board s credibility with shareholders. Increase board awareness of the long-term interests of shareholders. Shareholder meetings could range in structure from open meetings (with no limitations on shareholder attendance) to more limited meetings involving only significant shareholders, such as institutional investors. With the likely impending universal application of say on pay proposals, companies should view these as opportunities for shareholder dialogue. For these proposals to be effective, it will require added burdens on both the board and shareholders to avoid the proposal turning into nothing more than a check the box exercise. Companies will need to foster increased communications with shareholders. Likewise, shareholders will need to invest the time to read and examine the materials provided and communicate back to the board. * * * * * The Executive Alert is prepared by Aon Hewitt s Executive Center of Technical Expertise led by Dave Sugar. Questions regarding executive compensation technical issues may be directed to Dave Sugar at or dave.sugar@aonhewitt.com. This report is a publication of Aon Hewitt, provides general information for reference purposes only, and should not be construed as legal or accounting advice or a legal or accounting opinion on any specific fact circumstances. The information provided here should be reviewed with appropriate advisors concerning your own situation and any specific questions you may have. Copyright 2009 Aon Hewitt 5 October 16, 2009 / Alert