The following is an excerpt from a conversation that took place at MLR Media’s 2024 Character of the Corporation conference.
SPEAKERS: MELISSA BUREK, partner, Compensation Advisory Partners LLC; DON DELVES, managing director, executive compensation, WTW; IRA KAY, managing partner, Pay Governance; CHARISSE LILLIE, director and compensation committee chair, Penn Mutual
LILLIE: How do you approach the construction of CEO compensation packages and how are you advising your clients to share this information with their stakeholders?
BUREK: You have to start out with principles and you need guidelines. You need to design a compensation program around the success drivers of the company, and that absolutely includes shareholder value creation. The success drivers will be unique in every company — when you design a program, it could be around a transformation, or growth, or acquisition. You also should be aware of the market. You may decide that you need to pay above or below the market, but you should be informed. And you need a business case — you need rationale. If you’re not basing a CEO pay program around competitive, you must be able to explain why.
As it relates to the compensation strategy, you need to know your stakeholders. You have one compensation program, but different stakeholders will be interested in different things. Know your stakeholders, know the message, know the content, and think about how you will be delivering them. Investors want to know how you’re supporting the business. The shareholder wants to know what we are doing to keep the CEO retained for the next five years and they are interested in performance. You have a proxy statement and you have a CD&A. That is your key communication tool. But you also have earnings calls and you also have shareholder engagement. You’ll have meetings with your shareholders. Focus on the business strategy and how the pay program supports it.
Employees will be interested in how the CEO’s pay program aligns with their program. If the merit budget is going down, employees probably do not want to hear that the CEO’s bonus was doubled over the prior year. They will hope that things are consistent between the executive pay program and theirs. That may not always be the case, but it’s up to committees and companies to provide directional alignment and the rationale and message for the shareholders. Also understand that things change. The economy changes and company performance changes continuously. Many committees, when they make a pay decision, they’ll ask for proxy disclosure to be crafted in advance. So that’s an additional exercise, one of many you should continue to do throughout the year.
KAY: There are two or three philosophical things that we bring to the table to try to address this issue. The first and the most important is we help the companies balance the tension to motivate the executives to create shareholder value in the context of say on pay votes and other external pressures. It’s not easy to do this because, if the company pays too much, there can be say on pay challenges. If the company pays too little, it can lose or fail to motivate the executive. Balancing that tension is very important and there can be tension in both good and bad years.
The next thing that is essential when we do this is to bring all the facts to the table, such as the market data and other factors. We conduct realizable pay analysis. We help the company to make sure the incentive goals are challenging. We test whether there’s alignment of incentive payouts and performance. Companies can use the SEC pay versus performance to tell the optimal story. That’s the approach we take to create effective designs and goals, all to create motivational and retentive executive incentive programs.
LILLIE: How can board members determine whether CEO pay is excessive? What are the standards and how do we manage that process?
DELVES: I think sometimes people say, “Well, I know it when I see it,” as was famously said in the Supreme Court case about pornography. Is executive pay the same way? I think some people think it is. And if your pay package makes it to the Chancery Court, it certainly could be perceived as excessive.
But that’s the top one-tenth of 1%. For the vast majority of cases, it’s more of a Goldilocks exercise. We want to get the compensation just right. And this is an area where you can answer that question pretty definitively. There is so much data that is available to you on CEO pay and executive pay in general from peer groups, publicly disclosed information and surveys. There really should be no question in your minds, if you’re on a committee, where your CEO stands relative to the market and relative to your industry. And there’s scads of data on how well your company is performing. You can line the information up and, if you don’t feel like you’re getting the right information from your consultant or from management, keep asking because the information is there.