June 30, 2021
June 30, 2021
More than any other standing board committee, the events of 2020 have arguably and fundamentally reshaped the role and function of the compensation committee.
What should be the compensation committee’s responsibilities in the oversight of human capital management and diversity, equity, and inclusion (DE&I) initiatives at the board, management, and workforce levels? How should the scope of that responsibility be reflected in the committee’s charter and reporting? And how do boards compensate executives effectively and fairly in an environment that has challenged each of them like never before? These questions were on the minds of some 45 Fortune 500 compensation committee chairs convened by NACD, Farient Advisors, and Weil, Gotshal, and Manges at an Advisory Council in the spring of 2021.
While both the pandemic and the social equity movement of 2020 challenged most business executives, they also created opportunities for companies and their boards to rethink how they approach and share their compensation and human capital management strategies. Historically, investors were the primary audience of the compensation committee, and the committee communicated its story to shareholders through the proxy statement’s compensation discussion and analysis (CD&A). With the emergence of environmental, social, and governance (ESG) issues as a key compensation metric, and the growth of the compensation committee’s involvement in human capital oversight, however, more stakeholders are now looking at the compensation committee’s strategy as a key part of the company’s ESG narrative. “As we look back on 2020, it was an extraordinary year. ESG accelerated, with a big focus on the S,” said Robin Ferracone, CEO and founder of the compensation consulting firm Farient Advisors. “As corporations consider their stakeholders—investors, lawmakers, customers, employees—everyone is looking for the story in terms of plans, goals, and how it advances the corporate strategy.”
In these still-early days of linking compensation to ESG metrics, some compensation committees are testing novel approaches, but many more are still uncertain about where and how they can most effectively share their stories. Does such a report belong in a special annual corporate social responsibility publication? Should it be posted on the company’s website? Or, as more companies are doing, should it be included in the CD&A?
While we have yet to see any prevailing best practices develop, the challenges of the last year did create an openness, and even an appetite, for trying new tactics and approaches when designing executive compensation plans. One speaker at the advisory council meeting explained that their company went through a bit of a transformation with respect to the way in which it approached the CD&A: “I had been advocating that we weren’t effectively sharing our strategy and link to pay for performance in our CD&A. This past year presented the opportunity to try something new. Before, we were too modest. The CD&A was matter-of-fact and focused on compliance. We missed the opportunity to use it as a part of our communications and [to] help tell the bigger story—and it was a good one. The refreshed CD&A in 2020 opened with a committee chair letter and investors found the CD&A fuller and richer as a result.” Delegates agreed that including the company’s goals, strategy, and achievements in the CD&A, in addition to the typical statistics, paints a more complete and aligned story of management’s work and its progress on ESG matters.
As with most nonfinancial metrics, there remain open questions about which framework is most relevant for businesses and, just as important, which provides investors with the data they need to compare businesses. Reporting frameworks such as the one created by the Sustainability Accounting Standards Board (SASB, which recently merged with the International Integrated Reporting Council to form the Value Reporting Foundation) provide one path forward for companies. A human capital management framework that is in development builds on the work SASB has already done in the ESG space. In parallel, the US Securities and Exchange Commission (SEC), under the new leadership of chair Gary Gensler, has begun to move toward a more structured reporting regime. As Adé Heyliger, a partner in Weil, Gotshal, and Manges’s public company advisory practice, explained, “No one should assume that the SEC’s recent rulemaking on human capital and diversity, equity, and inclusion is the objective. These early, principles-based steps are just the first. We should expect, and begin preparing now for, more detailed reporting requirements in the medium-term horizon.”
Investors have also expressed their expectations over the years. One investor group, The Human Capital Management Coalition, submitted a petition to the SEC for a rule that would require “issuers to disclose information about their human capital management policies, practices, and performance.” During the session, a leading member of the coalition distilled its expectations down to just four metrics that it believes most effectively tell the story of any organization’s human capital management:
In the coalition’s view, these metrics, individually and collectively, are critical to understanding the total picture of the state of a company’s human capital and the potential for long-term success.
A more-structured reporting framework is likely to come as the SEC, investors, and independent reporting standards such as those of the SASB align around common metrics. For boards, that means doing the work now to identify the metrics most critical to your businesses and building the discipline and infrastructure necessary to capture those metrics, develop baseline goals, and shape a narrative around the human capital strategy.
The compensation committee’s agenda has long focused on more than just the statutory responsibilities of compensation for the CEO and named executive officers. Referring to the committee as the compensation committee is in some ways an inadvertent relic of language choices appearing in previous regulations and may mask the true scope of its current responsibilities. To that end, Advisory Council delegates discussed how they think about the committee’s work. From changing the committee’s name to updating the committee’s charter to reflect additional areas of oversight, committees that have long been focused on the expanding human capital oversight mandate are now realizing that they have an important opportunity to share the committee work that is underway with their stakeholders.
Some examples of new committee names that more accurately reflect the changing scope of the committee are the “talent management and compensation committee,” the “compensation and human capital committee,” and simply the “human resources committee.” With respect to committee charters, the updates focus on several newer areas of human capital oversight, including retention, diversity and equity, turnover, pay equity, talent management plans and practices, succession planning, employee engagement, and corporate culture.
Some in the investor and regulatory community may cynically regard these changes as merely cosmetic. Following through with effective engagement and disclosures, particularly through the CD&A section of the annual proxy statement, can start important conversations with investors around the company’s human capital strategy and its alignment with the organization’s overall strategy.
The changes now playing out have long been in the works at the compensation committee level. The increased focus and discipline in the human capital oversight area did not come as a surprise to the committee chairs present. What has created challenges for compensation committees is the speed at which several streams of work converged at the same time: human capital broadly, DE&I, increased disclosure requirements, and growing investor expectations. But the decisions and plans that compensation committees implement now will lay the groundwork for future developments.
Note: The meeting was held using a modified version of the Chatham House Rule, under which participants’ quotes are not attributed to those individuals or their organizations, with the exception of cohosts.
Read the full Advisory Council brief here.
NACD: Tools and resources to help guide you in unpredictable times.