Towers Watson s Principles and Elements of Effective Executive Compensation Design A Powerful Framework for Pay Decision Makers
An Important New Resource for Executive Compensation Program Design With the advent of say on pay in a growing list of countries and intensifying shareholder, government and public scrutiny of executive pay in major corporations worldwide, executive compensation (EC) has become a lightning rod for criticism. To many critics, today s executive pay practices are emblematic of how organizations govern themselves and respond to the concerns of various stakeholders. In this challenging environment, a number of forces for greater conformity in pay program design are at work, from a growing reliance on market norms and best practices, to the increasingly prominent role of proxy advisors in recommending how investors should cast their say-on-pay votes. For most companies, however, more tailored approaches should be driving pay decisions. Just as companies business strategies, organizational cultures and talent needs differ, so should their approaches to the design of their EC programs. Clearly, there is no dearth of opinions on pay levels and practices today, and no lack of proposed cures for perceived problems and shortcomings. But is executive pay really broken, as some critics contend? Are there opportunities to improve pay program effectiveness? Or is there a body of sound practices and outcomes? To help answer these questions, Towers Watson s market-leading Executive Compensation consulting practice embarked on an ambitious project to research the full range of views on pay for senior executives to see if a consensus is emerging on what s working and what s not. We also conducted additional research on EC program effectiveness using our many proprietary surveys and databases, and leveraging publicly available data. With this combined scan of the current landscape and our research, we then conducted a series of in-depth workshops to distill the insights and experience of more than 100 of our senior EC consultants, as well as a range of companies and directors. In parallel, The Delves Group (now part of Towers Watson) formed the Independent Directors Executive Compensation Project, which collected the views of hundreds of board members across various organizations and industries to develop core principles for the governance of executive compensation. The collective results of these efforts are Towers Watson s Principles and Elements of Effective Executive Compensation Design: a detailed and flexible framework of recommendations and considerations for pay program design that can help EC practitioners, corporate management and boards make better decisions about what and how to pay their top executives. What s critical is to focus on pay designs that are responsive to each organization s unique needs, rather than focusing heavily on external norms and generic standards. Principles and Elements of Effective Executive Compensation Design 1
A Comprehensive Framework for Decision Making The principles touch on virtually all aspects of EC and the process by which pay decisions are made from the overarching pay philosophy, to the art of peer group selection and benchmarking, to the fundamentals of performance-based pay program design and beyond. The following is an overview of many of the topics covered. Section I Section II Section III Section IV Section V Section VI Governing Objective and EC Philosophy Pay-Level Reference Group Selection and Benchmarking Market reference group selection Market pay-level benchmarking Adjustments to individual compensation Performance-Based Pay Performancebased pay mix and incentive funding Incentive vehicle selection Performance measure selection Target and range setting Role of discretion Pay-forperformance assessment and disclosure Governance Role of the compensation committee Ensuring proper governance of EC Public disclosure and shareholder engagement Other Terms and Conditions Risk mitigation and management Share ownership guidelines Clawback policies Perquisites and tax gross-ups Employment contracts Retirement arrangements Special Circumstances Incoming executives Ongoing and recruitmentrelated compensation Retention awards Terminationrelated compensation Change-in-control provisions The principles are a powerful, but flexible, framework for assessing and improving executive pay programs. 2 towerswatson.com
Putting the Principles to Work The principles provide a robust framework to support the effective design, governance and ongoing management of thoughtfully tailored pay programs. They re designed to help companies craft pay programs for executives at all levels, recognizing that programs can vary across different groups of executives. Perhaps most important, the principles offer a highly versatile compilation of knowledge, insights and recommendations that can be helpful to everyone involved in the executive pay process: For boards and compensation committees, the principles offer a robust framework for evaluating and fine-tuning overall compensation strategy, as well as overall pay program and governance effectiveness. For company management, the principles offer insights to help align pay with a company s strategy and business context, as well as detailed recommendations concerning business-critical areas such as plan design, the selection of appropriate performance metrics and effective target setting and calibration. For EC and HR professionals, the principles provide practical guidance and insights on in-depth pay design and administration activities, as well as day-to-day compensation issues. We have also created an in-depth assessment tool that Towers Watson consultants can use to evaluate how closely aligned their clients pay programs are with the guidance embodied in the principles. The tool is flexible enough to address the totality of a company s EC programs or to focus on specific executive categories, such as the CEO, other senior executives (e.g., named executive officers) or the broader executive population. Results can be assessed on a principle-by-principle basis or by overall topic area. Ultimately, the intent of the assessment framework is to support an informed and structured dialogue about the effectiveness of a company s EC programs. If further analysis or design should be considered, the framework can help to prioritize and guide specific actions. Importantly, the framework is not intended to provide a definitive or binding rating of any kind it s an internal reference only. Sample summary assessment output by topic area Topic area 1 2 3 4 5 Low alignment Alignment High alignment Pay-level reference group selections and benchmarking Performance-based pay (overall) Mix, measures and funding Targets, ranges and discretion Pay-for-performance assessment and incentive program review Governance Other terms and conditions Special circumstances Principles and Elements of Effective Executive Compensation Design 3
A Final Word Our detailed principles, elements and considerations for design were distilled from our research and wealth of experience consulting to the world s leading organizations. While we believe that most of these principles can effectively be applied to organizations in all parts of the world, they are most relevant to organizations that are publicly traded, and are subject to the more stringent governance environment of North America and Western Europe. In view of the unique and evolving regulatory environment of the financial services sector, these principles are not intended to apply to financial services organizations. We encourage organizations to apply these principles thoughtfully and flexibly, rather than automatically. There are clearly valid exceptions to the general rules practices that in many organizations appear problematic, while making perfect sense for a few. It s important to remember that no two organizations are alike, and there will always be unique and highly successful outliers. We view the principles as guidelines that will work for most organizations most of the time. We view the principles as reflecting a point in time. Organizations and their leaders change and evolve, and the external environment (e.g., legal, tax and social) is in constant flux. Our intention is to revisit these principles periodically to ensure they remain relevant over time, and reflect future research and experience. In short, the principles are designed to be helpful, not prescriptive. For more information For more information about the principles, or to request a copy of the detailed principles or an assessment of how closely your EC programs align with the principles, please contact your Towers Watson consultant or go to http://contact.towerswatson.com and complete the online form to register your interest (be sure to mention EC Principles as your area of interest). 4 towerswatson.com
About Towers Watson Towers Watson is a leading global professional services company that helps organizations improve performance through effective people, risk and financial management. With more than 14,000 associates around the world, we offer consulting, technology and solutions in the areas of benefits, talent management, rewards, and risk and capital management. Copyright 2014 Towers Watson. All rights reserved. TW-NA-2014-36541 towerswatson.com