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Balancing Vested Interests
Photo credited to Jessica Boehman (click to learn more about Ms. Boehman)
Executive compensation & benefits (C&B) is more of an art than it is a science. It has to protect shareholder interests, ensure board oversight & manage employee pay expectations. There is no cookie-cutter, one-size-fits-all definitive solution when designing C&B strategy or plan. How much is enough is dependent on business strategy, profitability, key performance indicator (KPI) metric selection, target achievement, outcome assessment & compensation calibration.
Fairly weighted C&B strategies & practices approved by a responsible board & management will ensure shareholder value is maximized, & retain talented employees to guarantee the long term success and preservation of the company.
This article will explore the perspectives, priorities, roles & responsibilities of shareholders, the board & the management.
Shareholders
Shareholders want to see a direct link between executive compensation & value creation, and rightfully demand from the board that this information is clearly & transparently communicated to them.
It used to be that shareholders had little say in how or what executives were paid. Management would lead compensation reviews, design C&B strategies, approve pay increases & negotiate new hire contracts. HR played an administrative role in collecting published salary benchmarking data to assess the competitiveness of pay. Finance would calibrate C&B awards based on what the budget could afford. The board would not interfere with the process, their approval often deemed only as a necessary informality.
Today, the favored corporate governance model increasingly favors shareholders. Boards & executives who ignore the importance of establishing a demonstrable link between executive pay & company performance might find themselves forcibly removed from office. Shareholders hold the board responsible for independently assessing the company’s performance & how it aligns to executive pay. Management is forced into taking a back seat on a process they previously led, their role being relegated to that of being counsel and advisor.
Shareholders must find the equilibrium between holding the board accountable & seizing control. Increased dialogue between shareholders and the board have already resulted in more transparent disclosure surrounding executive pay, curbing of imprudent non-performance related compensation & removing of lavish golden handshakes.
If shareholder activism is taken to the extreme, the company will be focused on the nomination of its directors & executive pay, rather than on running a profitable business. The cost of corporate governance will escalate exponentially, & will negatively impact shareholder value creation. Smaller companies might then consider the option of privatization, which would allow for quicker decision making & a lower cost of doing business.
The board of directors
Historically, the board of directors contributed insignificantly to the process of establishing executive pay. Long serving directors often had an implicit trust in the management, leading to little or no independent review of the chosen executive pay structure. Reward recommendations presented by management would almost certainly be approved as long as it was “intuitively reasonable”.
Today, boards face heightened examination from shareholders, the media, regulators & legislators to audit the process of how executive pay is established. Boards are expected to unbiasedly evaluate & validate the chosen pay structure, question the plan design & its assumptions, & to provide guidance based on their combined knowledge & experience. These expectations have led to boards convening more frequently to keep abreast on ever-changing statues on executive renumeration.
The board’s main consideration is how their decisions surrounding pay structure will appear to shareholders. Elevated scrutiny of the roles and responsibilities of directors serving on the board has raised their liability, encouraging many directors to embrace a risk management approach when dispensing with their fiduciary responsibilities.
More than just being “intuitively reasonable”, directors must be able to defend decisions taken when approving C&B strategies & reward structures. Boards must elucidate why certain KPI metrics are selected, how these KPI metrics maximize value creation, profitability & shareholder return, and justify how peer companies are chosen as reasonable comparators for C&B benchmarking.
Management
Rising shareholder involvement has diminished management’s influence over the executive renumeration process. In the past, management owned the entire process, and autonomously made decisions based on what they thought was best for the business.
But this led to some shareholders questioning if some of the decisions taken were more self-serving than in the best interests of the business, and executives today are increasingly spending more time justifying the decisions they take on pay.
Even in the face of these changes, management must continue to actively drive the renumeration process, welcome independent assessment, defend decisions taken & yet be open-minded to fine tune their C&B strategy & practices when necessary. Essentially, management must demonstrably link executive compensation & long term value creation, & clearly communicate the chosen strategy to shareholders & the board.
It is the responsibility of management to educate shareholders & the board of the company’s unique business culture and environment, & C&B strategies & practices adopted must give consideration to the company's distinct business culture & environment.
Shareholders might prefer a simple C&B strategy with cookie-cutter KPI metrics like total shareholder return (TSR) & earnings per share (EPS), but these generic metrics might not be enough to capture the special business context the company operates in.
Without factoring in the specific business context, company culture & industry environment into the C&B strategy, executives will find it hard to attract & retain human capital & talent. Planning a well thought through C&B strategy requires the company to customize its reward structure to suit its distinctive business conditions & company culture.
Fairly weighted C&B strategies & practices approved by a responsible board & management will ensure shareholder value is maximized, & retain talented employees to guarantee the long term success and preservation of the company.
This article will explore the perspectives, priorities, roles & responsibilities of shareholders, the board & the management.
Shareholders
Shareholders want to see a direct link between executive compensation & value creation, and rightfully demand from the board that this information is clearly & transparently communicated to them.
It used to be that shareholders had little say in how or what executives were paid. Management would lead compensation reviews, design C&B strategies, approve pay increases & negotiate new hire contracts. HR played an administrative role in collecting published salary benchmarking data to assess the competitiveness of pay. Finance would calibrate C&B awards based on what the budget could afford. The board would not interfere with the process, their approval often deemed only as a necessary informality.
Today, the favored corporate governance model increasingly favors shareholders. Boards & executives who ignore the importance of establishing a demonstrable link between executive pay & company performance might find themselves forcibly removed from office. Shareholders hold the board responsible for independently assessing the company’s performance & how it aligns to executive pay. Management is forced into taking a back seat on a process they previously led, their role being relegated to that of being counsel and advisor.
Shareholders must find the equilibrium between holding the board accountable & seizing control. Increased dialogue between shareholders and the board have already resulted in more transparent disclosure surrounding executive pay, curbing of imprudent non-performance related compensation & removing of lavish golden handshakes.
If shareholder activism is taken to the extreme, the company will be focused on the nomination of its directors & executive pay, rather than on running a profitable business. The cost of corporate governance will escalate exponentially, & will negatively impact shareholder value creation. Smaller companies might then consider the option of privatization, which would allow for quicker decision making & a lower cost of doing business.
The board of directors
Historically, the board of directors contributed insignificantly to the process of establishing executive pay. Long serving directors often had an implicit trust in the management, leading to little or no independent review of the chosen executive pay structure. Reward recommendations presented by management would almost certainly be approved as long as it was “intuitively reasonable”.
Today, boards face heightened examination from shareholders, the media, regulators & legislators to audit the process of how executive pay is established. Boards are expected to unbiasedly evaluate & validate the chosen pay structure, question the plan design & its assumptions, & to provide guidance based on their combined knowledge & experience. These expectations have led to boards convening more frequently to keep abreast on ever-changing statues on executive renumeration.
The board’s main consideration is how their decisions surrounding pay structure will appear to shareholders. Elevated scrutiny of the roles and responsibilities of directors serving on the board has raised their liability, encouraging many directors to embrace a risk management approach when dispensing with their fiduciary responsibilities.
More than just being “intuitively reasonable”, directors must be able to defend decisions taken when approving C&B strategies & reward structures. Boards must elucidate why certain KPI metrics are selected, how these KPI metrics maximize value creation, profitability & shareholder return, and justify how peer companies are chosen as reasonable comparators for C&B benchmarking.
Management
Rising shareholder involvement has diminished management’s influence over the executive renumeration process. In the past, management owned the entire process, and autonomously made decisions based on what they thought was best for the business.
But this led to some shareholders questioning if some of the decisions taken were more self-serving than in the best interests of the business, and executives today are increasingly spending more time justifying the decisions they take on pay.
Even in the face of these changes, management must continue to actively drive the renumeration process, welcome independent assessment, defend decisions taken & yet be open-minded to fine tune their C&B strategy & practices when necessary. Essentially, management must demonstrably link executive compensation & long term value creation, & clearly communicate the chosen strategy to shareholders & the board.
It is the responsibility of management to educate shareholders & the board of the company’s unique business culture and environment, & C&B strategies & practices adopted must give consideration to the company's distinct business culture & environment.
Shareholders might prefer a simple C&B strategy with cookie-cutter KPI metrics like total shareholder return (TSR) & earnings per share (EPS), but these generic metrics might not be enough to capture the special business context the company operates in.
Without factoring in the specific business context, company culture & industry environment into the C&B strategy, executives will find it hard to attract & retain human capital & talent. Planning a well thought through C&B strategy requires the company to customize its reward structure to suit its distinctive business conditions & company culture.
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