FROM GOVERNANCE TO STRATEGIC DESIGN IN EXECUTIVE COMPENSATION

It may be that the “governance” phase of executive compensation, which started with the Enron scandal in 2001, is coming to an end 15 years later.

During this phase we have seen shareholders and shareholder advisory firms assert their influence over executive compensation in large, US public companies. We have seen the power of board compensation committees and their independent consultants increase at the expense of management and their consultants. We have seen the transparency of executive compensation in company proxy statements improve. We have seen companies design and administer executive compensation to win favor of shareholders in “say on pay” votes. And we have seen “pay-for-performance” become the conventional goal of virtually all companies, with performance increasingly defined as stock price vs the market or peer companies.

Much of this is for the good. So, what’s to complain? Well, two things. First, the governance phase has contributed to managerial short-termism as companies try to keep shareholders happy with strong stock price performance. Second, it has led to homogenization of executive compensation programs as companies mold their programs to meet the predilections of the big shareholder advocacy firms, ISS and Glass Lewis. What has been lost is unique equity incentive plans creatively designed to support and reinforce the long term business and market strategy of the company.

Why are such plans discouraged under a governance-driven mandate? Let’s reverse the question. Why would a company embrace a plan that is unique and hard to understand and difficult to compare when it is consumed with winning shareholder support for it pay plans and wants to stay out of the gun sights of ISS and Glass-Lewis?

Why do I think the governance phase of executive compensation will end? Because all phases end. Because business managements happily have a great ability to absorb and adapt to new regulations and challenges, in time, and emerge intact to continue to grow and prosper through multiple generations. And because the governance advocates have essentially won.

So what’s next? I don’t pretend to see the future. But I do know what would be desirable. And that would be move away from uniform executive compensation plans, whose defining virtue is that they are the same as everyone else’s plan, to plans that are uniquely designed to support the company’s strategic business objectives.

Why would a company want to have a pay plan like everyone else’s? Why would a company not want to have a pay plan that provides it with a competitive advantage versus others? If your pay plan is the same as others, then all you can compete on is amount. And someone can always beat you. Your plan could be both ineffective, because it doesn’t help you attract and retain the types of talent you need to succeed, and inefficient, because a dollar of compensation expense is not likely to be perceived as a dollar of value received.

But, if you have a unique pay plan, aligned with the culture and strategy, and supported fiercely by management, you have a plan with opposite effect — potentially both effective and efficient.

To develop a pay plan that is aligned with the culture and strategy and supported fiercely by management, you have to be both creative and persuasive, something that is not required if your goal is to have a pay plan like everyone else.

What does being creative in strategic compensation design mean? To me, it means two things. First, it means being creative in selecting or designing the compensation tools that will comprise your pay program. For example, a stock option is a compensation tool, and incidentally, one of the simplest and most elegant tools ever developed.

Second, it means being creative in putting the compensation tools together in a comprehensive program uniquely designed and administered to support the culture and long-term business strategy for sustainable growth and success.

It’s tough to write about putting compensation tools together in a comprehensive strategic compensation plan because each plan has to be situation specific.

Developing new compensation tools is very challenging and rewarding. I don’t think there has been any innovation in the design of compensation tools in over 10 years. I hope to encourage the development of new tools through this Medium post, followed up with examples of cool ideas in equity incentive design to stimulate new thinking by compensation professionals who wish to practice at the highest level in the field. For those interested and challenged, these examples will be posted periodically (hopefully, one a week) on my website, fwcadvisoryhome.com.