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Reader Profile

Joseph R. Rich
President
Pearl Meyer & Partners

Editor's note: Each month, we ask a Directors & Boards reader to comment on critical issues facing directors today. If you'd like to participate in this section in the future, please email Scott Chase.

What is your view of the proposed SEC Guidelines on executive compensation disclosure?

It’s hard to fault the SEC’s very democratic notion of giving shareholders more information about how the people responsible for running America’s public companies are paid. Companies give great lip service to “paying-for-performance,” but right now they’re not required – and few have volunteered – to give much detail about how their compensation incentives are aligned with shareholders’ interests. The proposed regulations will certainly help clarify the true cost and the rationale behind highly complex executive pay programs. Among other requirements, the SEC wants companies to provide a standardized valuation of stock and stock option awards and some popular and highly lucrative compensation arrangements that currently fly under shareholders’ radar.

Is more disclosure likely to have a moderating effect on pay levels?

The SEC believes that providing detailed information on compensation in “plain English” will empower shareholders to push for better pay programs, force Boards to react decisively and shame overpaid executives into toning down their demands.
That’s possible, but I think we also need to remember that detailed marketplace information on pay is of keen interest not only to investors, but also to top executives who are eager to compare their paychecks with their peers. Increased disclosure will enable managers and their advisors to more easily compare competitors’ programs on a dollar-for-dollar basis and also create more data points for competitive benchmarking by making data in compensation surveys more readily available. Program comparison generally leads to gap identification. We know from experience that when gaps are discovered in executives’ pay packages, their reaction is to want it filled – and fast. The result would be to further ratchet up pay levels.

How is greater transparency likely to impact compensation committees?

Committee members are going to find their decisions put under the investor microscope to an even greater degree than before. Committees will need to develop and communicate clear processes for decision-making, if they haven’t already done so. The proxy will need to annually include an explanation, in detail of the committee’s compensation philosophy and how it was put into practice over the previous year. The proxy also will need to include much more detailed data on just about every element of executive compensation programs. As part of their fiduciary responsibilities, directors will be held responsible for ensuring the objectivity and independence of any outside consultants they retain.

Why would the comp committee choose to hire its own consultant?

Every firm will need to consider the best approach for their needs. Overall, the new SEC disclosure rules make it more important than ever that the compensation committee eliminate even the suggestion of a potential conflict of interest. Having a compensation consultant who works exclusively with the committee and not with management can help protect members from irate shareholders, or worse, shareholder law suits.

In fact, our firm recently surveyed the views of companies on this very subject. The results were revealing.

•    A significant majority of respondents – including nearly almost 85% of the public firms -- believe the compensation committee should retain its own dedicated consultant. However, at the time of the survey fully one-third of these same firms had not done so.

•    More than half of all respondents -- including 54% of the public firms -- said the same consulting firm should not serve both management and the committee.

•    Almost 45% of the publicly traded firms said that having the same consulting firm for management and the committee creates the appearance of a conflict of interest, even though only 11% believe it might constitute an actual conflict..

Should the compensation committee’s consultant have any contact with management?

The key is that the committee’s consultant be truly independent of management, so that shareholders know the decisions made are objective and proceed from a well-reasoned process. That means that the compensation consultant should be hired directly by the committee and should clearly understand the reporting relationship.

That doesn’t mean there can’t be any contact - a balanced approach is best. An effective and trusted consultant can play a useful crossover role by also serving as the comp committee’s representative to management, providing its perspective and working with management to develop recommendations that meet the committee's needs and shareholder's expectations.

Should management be provided with its own compensation consultant?

Not necessarily. While the adversarial approach of providing advice and counsel from both perspectives can offer the benefit of role clarity, shareholders may well be troubled by the idea of footing the bill for management's advocate.

What is the bottom line consideration?

In the end, the true value of a compensation consultant is that there is an additional experienced person considering the situation, identifying and evaluating potential solutions, and making expert recommendations accordingly.

Any final thought on the SEC’s proposed guidelines?

Heightened disclosure rules ideally will be a powerful incentive for Boards to view executive compensation programs more closely and holistically, so that all elements of pay are analyzed relative to their risks, rewards and potential to deliver real value to shareholders. If that happens, regardless of whether overall executive pay levels decline, the SEC will have taken a major step toward making pay programs more equitable and truly performance-based.

Joseph R. Rich is President of Pearl Meyer & Partners, where he consults in the areas of executive, sales, and employee compensation. Before joining the firm, Rich was a co-founder and managing partner of Executive Alliance, a leading compensation-consulting boutique that was acquired by Clark Consulting in 2001. Previously, Rich was a Principal and elected officer of William M. Mercer, Incorporated, where he served as a member of the national executive compensation practice. He also served as a Consulting Manager in the Human Resource practice of KPMG/Peat Marwick and held a variety of positions at Data General Corporation

Rich’s articles have appeared in Perspectives in Total Compensation, Personnel Psychology, The Journal of Employment Management, and Pension World. He is a Certified Compensation Professional and member of WorldatWork, where he was formerly an instructor.

Rich holds an M.S. in Human Resources and Statistics and a B.S. in Economics, both from Cornell University, where he also served as a Lecturer in Economics and Statistics.

Pearl Meyer & Partners invites readers of Directors & Boards to visit www.pearlmeyer.com to download articles related to the SEC disclosure guidelines .