NACD Directorship: A Wish List for Comp Committees

NACD Directorship: A Wish List for Comp Committees

January 17 2014

JanFeb 2014 Viewpoint - A Wish List for Comp Committeesby Steven E. Hall

The new year is upon us, and with it a time to consider wishes to incorporate into our resolutions. In considering the challenges faced by compensation committees in the coming year, the following is my wish list for 2014.

Start Drafting the 2014 CD&A With a Clean Sheet of Paper
When the Securities and Exchange Commission (SEC) modified disclosure guidelines to require the Compensation Disclosure & Analysis (CD&A), it envisioned a document that would avoid boilerplate language and use plain-English, principles-based disclosure to inform shareholders about the programs in place and how they support the ultimate objective of growing long-term shareholder value. Since then, new regulations and “best practices” have expanded the required information. Rather than using a clean-sheet approach, most companies have simply “bolted on” additional disclosures, making CD&As long, tedious, repetitive, and worst of all, confusing. While some of this additional disclosure is a direct response to the real threat of shareholder litigation around poor disclosure, often the result has been that the “compensation story” is lost entirely.

I wish that companies would begin drafting their 2014 CD&As with a blank sheet of paper and a commitment to give shareholders a succinct but comprehensive overview of the compensation program in an easy-to-read, graphic-intensive format. I’m not alone in this wish. In her speech to the NACD Board Leadership Conference in October, SEC Chair Mary Jo White exhorted companies to avoid “too much of a good thing” and to consider whether repetition could be avoided within SEC disclosures.

Proactive Shareholder Outreach
While many companies say that shareholder outreach is an area of focus, in my experience it is often a reaction to a problem, such as a negative ISS recommendation. Many view it as unnecessary because in the prior year they passed with shareholder approval numbers of greater than 90 percent. The reality is that in recent years, over 20 percent of the companies that failed say-on-pay votes had passed in the prior year with 90 percent or better support. Past votes are not a guarantee of future votes.

I wish companies would be more diligent about proactive outreach efforts. Directors should make sure to communicate regularly with shareholders on governance- and compensation-related topics, making sure that they understand how the program is perceived, including areas of real or potential concern. Good shareholder outreach involves at least as much listening as it does talking. While it may seem unnecessary to go to this level of effort when there doesn’t appear to be an immediate problem, these meetings are an important way to build goodwill and mutual understanding, and can serve as helpful points of reference when directors consider modifying existing programs or implementing new ones.

Peer Groups
I continue to find that compensation committees spend an extraordinary amount of time on peer groups. While it is certainly important to have the best group possible, both for purposes related to sound compensation administration as well as shareholder optics, in my experience no peer group is perfect. Additionally, I find that they have limited usefulness for positions other than the CEO, CFO, and possibly one or two others. More important is the recognition that any peer group is only a starting point for determining compensation. Director discretion is more important than the perfect composition of the group. Thus, seek to ensure that the group remains appropriate from the perspectives of size, business mix, and competition for revenues and talent.

Consider Pay-for-Performance Disclosure Before Finalizing Performance Pay Decisions
While most directors are very comfortable with realized pay disclosure in instances where performance did not materialize and pay was cut commensurately, once this disclosure is incorporated into the CD&A and other shareholder outreach materials, removing it can be difficult. Prior to finalizing pay decisions, I wish directors would review models of potential payouts and draft tabular disclosure to ensure that they are comfortable with how this disclosure will look in light of different performance scenarios. Likewise, prior to approving changes to compensation plans, review a draft of the relevant CD&A disclosure. This effort in 2014 will go a long way toward avoiding unpleasant surprises in the future.

Annual Reviews of Director Compensation
Directors should be mindful of the early signs of a troubling backlash against director compensation. Over the past year, members of the media and others have begun to raise questions such as “What are we paying directors for?” and “Should directors be paid for performance?”

While these questions suggest a lack of understanding about the role of directors and the level of experience, expertise, and insight they bring to the boardroom, it nevertheless indicates that director compensation will no longer fly under the radar. I wish directors would consider director compensation on an annual basis, to ensure that year-over-year adjustments to remain “at market” remain modest, rather than being forced into large catch-up adjustments every several years that will likely need to be justified and defended. That said, expanding the explanation of the rationale behind director pay and the time and efforts of directors in the proxy may well be a helpful addition to address the concerns of outsiders.

Limits on Share Awards in Director Plans
In 2012, in Seinfeld v. Slager, the Delaware Chancery Court refused to provide protections under the business judgment rule where directors had awarded themselves annual equity grants under a plan that lacked “sufficiently defined” limits on the size of director awards. Most equity plans contain these limits for executives [to satisfy deductibility requirements under 162(m)], but do not include separate limits for awards to directors.

In 2014, I wish directors would request that plan documents for active equity plans are reviewed and consider the inclusion of sufficiently defined per-person limits on the number/value of shares that can be awarded annually to a director. When establishing the size of the limit, directors should give consideration to general industry director compensation trends and the impact of company size, prevailing director compensation levels, and the views of shareholders, which might affect the size of the limit. Including these limits is relatively simple and may afford protections to directors.

Courage and Commitment
Being a director has never been harder, and the quality, knowledge, and work ethic of today’s directors have never been better. Demands on directors have increased, as have the number of constituencies that feel entitled to comment on their decisions, often with the benefit of 20/20 hindsight. Given all of the noise and distractions, it can be easy to lose sight of what members of the compensation committee are charged with overseeing: a well-designed compensation program that attracts, motivates, and retains executives needed to achieve the company’s strategic objectives and create long-term value for shareholders. My biggest wish for 2014 is that directors continue to focus on this overarching objective, and have the courage to make and defend decisions needed to accomplish it, especially in instances where the decision might go against “best practices” as defined by outsiders, but reflect the best practice for their company.

The roles and responsibilities of those whose task it is to safeguard and increase shareholder value have never been greater. Make no mistake that the wishes presented recognize the great strides that boards have taken in recent years. Continuing to get better, however, is a great New Year’s resolution for all of us.

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