The recently enacted financial regulation, the Dodd-Frank Act, requires a non-binding shareholder vote on executive compensation, beginning in 2011. Known as “say on pay”, this requirement calls for publicly traded companies to hold these votes every one, two or three years.
Compensation committees should perennially endeavor to base pay plans on sound compensation principles that ultimately align executives with long-term shareholder interests. Nevertheless, committees are well-advised to be mindful of how specific elements of their compensation program might be viewed in the coming say on pay environment.
To prepare for say on pay, compensation committees should consider conducting a governance audit of their executive pay programs. Among the areas that this audit should cover are:
- Pay levels. Ensure that target and actual pay levels meet business and talent objectives while considering internal pay relationships (the subject of new disclosure regulations). Also, assess pay levels against external benchmarks such as those of peer-group companies.
- Incentive compensation. Confirm that compensation plans support business objectives, and that they actually pay for the performance desired, by assessing incentive-pay measures and goals as well as incentive-pay mix (i.e., short-term and long-term incentives, and cash versus equity). Try to avoid or minimize pay practices that may raise governance concerns, such as guaranteed non-salary compensation, discounted options or option re-pricing without shareholder approval.
- Shareholder alignment. Mechanisms such as ownership guidelines, stock holding requirements, anti-hedging policies and clawback provisions should be assessed to ensure that they meet governance standards and comply with the new legislation, as applicable.
- Perquisites and benefits. Excessive perquisites, tax gross-ups on perquisites and excessive benefits such as pension credit for years not worked are lightning rods for governance criticism. Evaluate any such practices in light of their cost and business rationales.
- Employment contracts and severance benefits. Assess such hot-button issues as severance payments in change in control (CIC) and non-CIC situations, accelerated equity-vesting triggered by a CIC, excise tax gross-ups and automatic contract renewals. Reconsidering these provisions–and making any appropriate changes–is crucial in light of the newly-required non-binding shareholder vote on golden parachutes.
- Disclosure. Ensure the Compensation Discussion & Analysis section of the proxy statement provides the rationales for compensation decisions in plain English. Information should be summarized using easy-to-read formats such as executive summaries and charts to give readers a rapid grasp of programs. Be sure to include clear disclosure of the business reasons for any divergence from best practices.
- Shareholder base. It is paramount for directors to know their shareholders and be mindful of their compensation governance standards, as well as those of shareholder advisory groups.
- Independence. Ensure that compensation committee members and committee advisors adhere to new independence standards.
- Leadership structure. Confirm disclosure provides a clear rationale why the company has chosen one person to serve as both board chairman and CEO, or different individuals to serve in these roles.
Insights gathered through such an audit will enable directors to enter uncharted say on pay terrain with their eyes wide open. Committees that are proactive will be better positioned not only to engender shareholder confidence in the short term, but also to enhance shareholder value for the long term.
Russell Miller is managing director of ClearBridge Compensation Group (www.clearbridgecomp.com), a New York-based firm that serves boards of directors.