by Todd Krauser, Pearl Meyer & Partners

Compensation committee members face many challenges related to executive compensation. Corporate governance guidelines, shareholder advisory concerns, and external optics are but a few of the issues directors must wrestle with on a regular basis. Most companies conduct annual or biennial compensation assessments to help directors evaluate the competitiveness of their executive pay programs. However, compensation assessment needs to go beyond simply reviewing market data. The key to an effective executive compensation program is an awareness of the impact to the organization caused by multiple relationships including business strategy, culture, talent, and pay philosophies.

A deeper dive into understanding the effect of pay programs can be triggered by any number of events. Some are obvious, such as a major strategic acquisition. Unfavorable results on a say-on-pay vote clearly demand review of pay programs. These are reactive responses. Compensation committees should not wait for a triggering event but should take a more proactive approach. An active, inquiring compensation committee can prepare for major strategic moves and prevent, or at least mitigate, the risk of unfavorable review by investors or investor advisory groups. Outlined below are a few methods directors can use to increase the value and contribution they make to the compensation design process.

Resist comfort with the status quo: Just because the plans appear to be “working” (i.e. inspiring the right performance goals) does not necessarily mean they are maximizing their potential. Test a contrarian point of view and challenge conventional thought. Such thinking can be hard to do in the current executive pay environment, which encourages uniformity in compensation plan design.

It behooves directors to ask questions such as “Why do we do it this way?” or “What would happen if we changed?” It is not just a matter of making change for the sake of change; it means pushing the boundaries to ensure the organization is not settling for suboptimal pay and performance alignment (i.e. paying too little for performance that exceeds peers or paying too much for performance that falls below peer results). Testing and challenging conventional thought can lead to new ideas that benefit the organization and its shareholders.

Ask the right questions: Are the compensation plans driving performance (i.e. incentive plan measures are selected based on their ability to lead behavior toward a specific objective) or are they paying for relative results (i.e. incentive awards are earned by beating peers)? Has the organization shied away from a particular design or strayed too far in one direction to satisfy external groups? Relative total shareholder return (TSR) plans may be the flavor of the month, but so were stock options in the ’90s, as was time-based restricted stock in the early 2000s, following the dot-com bust.

Many good ideas get discarded due to fear or threat of negative reaction from watchdog groups, but reconsider all ideas and evaluate concepts from both an external perspective (e.g. market practices, shareholder expectations) and an internal perspective (e.g. business strategy). Don’t let market data or external influences be the main driver in decisionmaking. Instead, let talent and business strategy shape decisions. Asking tough questions and digging deeper into the issues always yields a better compensation design process.

Take a holistic look at pay: Commonly used tools such as tally sheets and wealth accumulation studies are helpful in understanding how much an executive has accumulated via the various compensation programs, but they fall short in evaluating some of the more strategic issues related to compensation. For example, does the pay program effectively address the implications of the business cycle or changing strategic priorities? Chances are the organization has experienced some change in recent years and compensation programs should reflect these changes.

For example:

• The selection of long-term incentive vehicles should be influenced by share price outlook and dividend strategy;
• The relative weight of retirement and insurance benefits may become more critical as leadership matures.

Competitive pay benchmarking and market trends analysis are helpful tools to guide decisions, but those activities by themselves should not be the foundation. By taking a proactive approach to challenge conventional pay design, compensation committees can better accomplish the true mission of aligning pay with performance in a way that reinforces the company’s strategic priorities.

Todd Krauser is a vice president in the Atlanta office of Pearl Meyer & Partners where he specializes in executive and board of director compensation issues including incentive plan design, pay for performance alignment, and corporate governance. He can be reached at (770) 261-4095 or todd.krauser@ pearlmeyer.com. You can also follow him on Twitter at Todd Krauser@ToddKrauser.