Data from the World Bank show that if the global nonprofit sector were its own country, that country’s GDP would represent the sixteenth largest economy in the world. In 2013, the most recent year for which data were available, the nonprofit sector contributed $905.9 billion to the U.S. economy, which is representative of nearly 5.4 percent of U.S. GDP. The nonprofit workforce also accounted for nearly 10 percent of U.S. employment, according to the Bureau of Labor Statistics’ latest calculation.
Nonprofit organizations frequently are managed by an impassioned group of people with a focused mission or social objective. Often equally passionate are the organization’s board of directors, elected to oversee the organization and ensure its long-term viability.
Nonprofit boards, however, aren’t beholden to the same regulations from the government and listing requirements that their public company peers are, nor do their organizations experience the same pressures from investors that their private company peers do (though, in some ways, a nonprofit board may have to cater to donors in a similar way that private companies cater to their investors). Though all company and organization types face some similar challenges, it can be reasonably expected that the governance landscape for nonprofits might evolve differently than that of private and public companies.
NACD recently analyzed the current state of nonprofit governance in its latest 2015-2016 NACD Nonprofit Governance Survey. The survey report was based on the responses from more than 600 directors serving a variety of nonprofit boards that have 16.4 members on average—much higher than the 8.9 directors on public company boards and the 7.6 directors on private company boards.
On the subject of director recruitment, 49 percent of respondents identified “experience specific to the organization’s mission” as the most sought-after attribute a new director could offer the board. A significant portion of respondents also gave priority to leadership experience (34%) and financial expertise (22%). Other sought-after attributes for director candidates include fundraising experience and commitment to the mission.
Related findings include:
80 percent of respondents report that their boards use personal networking to identify new director candidates.
20 percent of respondents from large nonprofits indicate their boards use search firms to identify potential board candidates, up from 12 percent in 2014.
A distinct aspect of nonprofit board service is the expectation that directors will actively participate in fundraising efforts for the organization. Sixty-eight percent of respondents indicate their organization engages in fundraising as a part of their business model. Yet, 51 percent of all nonprofit survey respondents say they feel unsure about the organization’s expectations for them to fundraise.
Related findings include:
54 percent of respondents from organizations that do engage in fundraising indicate that there is a documented fundraising strategy for the board.
34 percent of respondents say their boards have a fundraising committee.
A strong majority of nonprofit respondents are satisfied with the quality of information provided to them on corporate performance (86%) and on strategy (84%). However, paralleling private and public company trends, nearly a fifth (19%) of respondents would prefer more information on the organization’s strategy—both short- and long-term objectives.
Related findings include:
60 percent of respondents report that their board does not receive enough cyber-risk information from management.
More than one-third of respondents reported they are dissatisfied with the quality of information provided to the board on risks related to technology (37%) and cybersecurity (48%).
For more research and analysis on the current state of nonprofit boards, please click here to access the full 2015–2016 Nonprofit Company Governance Survey.
“It ain’t over ‘til it’s over.” Truer words were never spoken when it comes to the new pay ratio rule.
A key chapter in pay regulations closed August 5, 2015 when the U.S. Securities and Exchange Commission (SEC) issued its final rule on the pay ratio disclosure mandated by the Dodd–Frank Wall Street Reform and Consumer Protection Act. This final rule capped a two-year comment period intended to resolve many thorny issues around exactly when and how to calculate the two numbers involved in the ratio—namely median employee compensation/CEO compensation. (To see NACD’s comment letter, visit the NACD Resource Center on Corporate Governance Standards and click on our Comment on Pay Ratio.) The NACD comment letter, like some others, noted that the “annual total compensation” figure can be misleading, and suggested solving this problem by asking the SEC to permit the use of industry averages, to limit employees to full-time domestic employees, and to permit supplemental notes. In its final rule, the SEC did not make these changes but did address concerns about total annual pay by allowing companies to use any “consistently applied compensation measure” (CACM) to calculate median annual compensation for employees.
This concept of a CACM led to questions, however. So on October 18, 2016, the SEC’s Division of Corporation Finance addressed them by updating its C&DI for Regulation S-K, one of the 32 “Compliance and Disclosure Interpretations” (C&DIs) the staff maintains on its most complex regulations. Although the five questions raised are technical rather than strategic, and represent only a tiny fraction of the many issues raised by the final rule overall, they still merit board attention. Therefore, this blog presents, in simplified English, the five ratio-relevant Q&As in the newly updated C&DI (codified under Section 128 C) and provides a key question and a final “takeaway” for boards.
Summary of the SEC’s Five Questions and Answers
Summary of Question 1: If a company does not use annual total compensation to identify the median employee, how should it choose another consistently applied compensation measure (CACM) to do so?
Summary of Answer 1: SEC’s updated C&DI assures companies that a CACM can be any measure that “reasonably reflects the annual compensation of employees,” but asks that companies explain their rationale for the metric they choose. An appropriate CACM will depend on “particular facts and circumstances,” says the SEC. For example:
Total annual cash compensation can work as a CACM, unless the company has also made a wide distribution of annual equity awards for the same period.
Social Security taxes withheld would likely not be an appropriate CACM unless all employees earned less than the Social Security wage base.
Summary of Question 2: May a registrant exclusively use hourly or annual rates of pay as its CACM?
Summary of Answer 2: No. Although an hourly or annual pay rate may be a component used to determine an employee’s overall compensation, the use of the pay rate alone generally is not an appropriate CACM to identify the median employee.
Summary of Question 3: When a registrant uses a CACM to identify the median employee, what time period may it use?
Summary of Answer 3: The SEC’s answer to this question says that the company must select a date within three months of the end of its most recent fiscal year to determine the population of employees from which to identify the median employee. The CACM need not be contemporaneous. In fact, it can come from the prior fiscal year, as long as there has not been a material change in the registrant’s employee population or employee compensation arrangements—that is, a change that would “result in a significant change of its pay distribution to its workforce.”
Summary of Question 4: What about furloughed employees?
Summary of Answer 4:The SEC’s response clarifies that the final rule identifies four classes of employees: full-time, part-time, temporary, and seasonal. It does not define or even address furloughed employees, because a furlough could have different meanings for different employers. It is a matter “facts and circumstances” and provides additional guidance on the matter.
Summary of Question 5: What about independent contractors? Under what circumstances can their pay be included in the CACM for the employee?
Summary of Answer 5:The final rule had stated that “leased” workers are excluded from the definition of employees “as long as they are employed, and their compensation is determined, by an unaffiliated third party.” The SEC’s answer preserves this distinction, and gives some flexibility. In determining when a worker is an “employee,” the company “must consider the composition of its workforce and its overall employment and compensation practices.” So a company should include workers whose compensation it (or a subsidiary) determines “regardless of whether these workers would be considered ‘employees’ for tax or employment law purposes.”
Are you familiar enough with compensation patterns in your company to know whether a chosen CACM “reasonably reflects” the compensation in your company? If not, you may wish to meet with the officer responsible for employee pay below the executive level to get a better sense of this important issue.
Compensation committees have traditionally focused on executive compensation, leaving employee compensation to management. In the past few years, however, several factors have combined to broaden the committee’s purview, including concerns about pay disparity, and the new requirement to disclose compensation risk. Therefore, more compensation committees are overseeing enterprise-wide pay. For example, in its 2016 proxy statement, WPX Energy disclosed that in the past year “With the oversight of our Compensation Committee, we conducted a risk assessment of the Company’s human capital with a focus on enterprise-wide compensation programs.” (Emphasis added.)
The key word in all of these questions and answers is “reasonably.” It is exactly the right word for compensation committees to use as they oversee this disclosure, as well they should.
Alexandra R. Lajoux is chief knowledge officer emeritus at the National Association of Corporate Directors.
As proxy advisors and shareholders continue to focus on improving the relationship between compensation and shareholder returns, and new pay for performance rules are finalized by the U.S. Securities and Exchange Commission, it is likely that more companies will consider adapting incentives based on Total Shareholder Return (TSR) principles. Ultimately, companies need to balance shareholder value creation with executive motivation and retention when deciding whether a TSR-based incentive plan is appropriate and aligns with the company’s compensation philosophy.
If TSR is utilized in a performance-based award package, companies need to consider the following three factors: whether TSR should be measured on an absolute or relative basis, the appropriate TSR performance hurdle, and whether there will be a cap on payouts based on absolute TSR performance.
1. Absolute versus Relative TSR. Absolute TSR requires the company to set stock price targets that must be achieved to earn a payout. Establishing an absolute stock price level at the beginning of a performance period can be challenging, as a declining stock market could make goal achievement difficult to achieve, while a “buoyant” stock market could make the absolute goal relatively easy to achieve. The challenge with relative TSR is that it requires the company to select a peer group or index that is appropriate for relative TSR performance comparisons. Identifying an appropriate comparator can be particularly challenging for companies in unique markets or industries with just a few competitors.
A well-designed TSR plan might provide that when a company achieves both low absolute TSR and relative TSR, little to no payouts would be allowed (Figure 1, box C); similarly, when absolute TSR and relative TSR performance are high, payouts would be sizable (Figure 1, box B).
In cases of high absolute TSR with low relative performance (Figure 1, box A), some type of reduction in payouts might be appropriate, as the company underperformed the stock market. Similarly, in cases of low absolute TSR and high relative TSR performance (Figure 1, box D), management could be rewarded for out-performing a down stock market.
Competitive practice, however, does not often combine these two concepts. Most plans are based on relative TSR, with no adjustment for absolute performance. The few companies that set absolute stock price (or TSR) goals do not consider relative performance. A few large companies have introduced payout caps when absolute performance is negative, a concept which is discussed below.
2.TSR Performance Hurdle. If absolute TSR is utilized, a company will need to decide a minimum stock price level that must be achieved to trigger a payout (e.g., the current stock price is $15, and a trigger price of $30 is established before a payout can be earned). Determining an absolute stock price, or TSR hurdle, should stretch the executive’s efforts, but should not be demotivating. That said, the performance of the overall stock market or the stock performance of the company’s industry sector can make the $30 target in the example either impossible or easy to achieve, which may not create the intended incentive.
For relative TSR, the company must decide the minimum level of relative performance compared to a peer group or market index that begins to provide a payout. This approach allows companies to avoid the need to set a specific stock price. However, it is important to remember that a relative TSR goal may not provide the intended motivation, as the goal is not as clear cut as the absolute stock price target (and, presumably, the underlying earnings or cash flow that must be achieved to support the target stock price).
A typical relative TSR performance curve for a US-based company is illustrated in Figure 2. The threshold level is often the most debated payout level on the performance curve, although competitive market practice suggests the 25th percentile is the most common threshold performance level. By way of contrast, a UK-based company would typically start payouts at 50thpercentile relative performance.
3. TSR Caps. In order to reward both relative and absolute performance, some companies with relative TSR plans have placed a cap on payouts when absolute TSR is negative. These caps often limit payouts to 100% of target despite the company’s ability to outperform in a down market, as shareholders lost value during the performance period.The obvious issue with this approach is the lack of symmetry. Specifically, if the share price increases significantly, but relative TSR is below the threshold level, no payouts will occur. Thus, shareholders will realize a significant increase in stock value and management does not receive a payout (contrast this result with stock options, where management would realize a significant amount of “intrinsic value”). The lack of symmetry and the general belief that out-performance in a down stock market should be rewarded has likely led companies to refrain from imposing caps on payouts.This may change as shareholders and the proxy advisory firms continue to apply pressure on companies to better align pay and performance. In addition, the SEC proposed rules required under Dodd Frank in July 2015 that when finalized will require disclosure of the relationship of pay and TSR (both relative and absolute). This disclosure could impact the design of incentive plans including TSR-based plans to further align realized compensation with shareholder returns (including the use of TSR caps).
Michael Kesner is principal and Jennifer Kwech is senior manager of Deloitte Consulting LLP’s Compensation Strategies Practice.
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