The Best Thing You’ll Read About Executive Compensation Today

It’s not me. It’s the report just issued by The Conference Board’s task force on executive compensation. You can find it at: http://www.conference-board.org/publications/describe.cfm?id=1692 For those who don’t know, The Conference Board is a non-profit organization that brings together business leaders to discuss important topics and provide, roughly speaking, the business community’s view of best practices. The committee that released the report was co-chaired by Robert Denham, former Chair and CEO of Salomon, and Rajiv Gupta, former Chair and CEO of Rohm and Haas.

The report is a clear and succinct review of both the general role and responsibilities of compensation committee members and the specific controversies and issues that comp committees are facing today. For someone stepping into a compensation committee position for the first time, the report is a great way to get up to speed quickly. For those with experience, it provides a nice tune up.

The report is also important because it is one of the first (and maybe the only) organized and coordinated responses of the business world to the increasingly aggressive posture taken by pay critics.  While everyone will find some points to quibble with, it is a calm thoughtful analysis, which makes it superior to much of what is published on this topic.

Here are a few important points made in the report:

-One-size fits all rules will fail. The report notes that there are more than 12,000 public companies in the U.S. Each has different circumstances and those circumstances change over time. Rule-based approaches cannot hope to succeed. Most of the tax law on executive comp is a perfect example (e.g. 162(m), which led to increased reliance on options; 280G, which lead to widespread use of tax grossups; 409A, which wasted vast amounts of shareholder wealth on compliance with trivial tax requirements).

-“Best practices” are not always the best for shareholders. As a corollary to the first point, the report notes that some companies in some circumstances will find that violating best practices is in their shareholders’ best interest. In fact, the report is very careful to avoid criticizing any specific pay practices on the merits. Instead, the report refers to them as “controversial pay practices”, and argues that controversy is generally worth avoiding unless there is a good reason to do so.

-Value of discretion. The report makes a case for comp committees to be free to adjust pay to account for whatever factors they think relevant. This view is somewhat controversial. If you look at the compensation debate over long periods, support for discretion ebbs and wanes. The view that comp committees abused discretion to overpay management was one of the culprits behind tax code 162(m) and 409A. Under the recent proxy rule changes, discretionary payments are relegated to the “bonus” column of the summary compensation table (which has negative connotations) rather than the better sounding “non-equity incentive compensation” column. I suspect many pay critics would be displeased to see compensation committees moving away from mechanical and formulaic compensation programs.

-External reactions (can) matter. In its discussion of controversial pay practices and other issues, the report notes that a poor public reception can harm the company even if the public reaction is wrong on the merits. It can hurt employee morale, disrupt management teamwork or damage relations with shareholders or regulators. It is in that light that the report suggests considering eliminating controversial pay practices and making better use of public disclosures (such as CD&A).

-Compensation decisions are inherently subjective.  Sounds obvious, and it is, but it has implications.  Subjectivity is an argument in favor of discretionary arrangements, which as noted above are somewhat disfavored and can be controversial.  It makes it easier for outsiders to criticize your decisions; after all, different minds can disagree on subjective decisions. In turn, this means that you can't please everyone all the time, and you shouldn't try.  Finally, it implies that general advice should always be taken with a grain of salt.  For example, if each member of your peer group made their comp decisions based on factors unique to them, how useful a comparison are they for you?