Tag Archive: compensation consultants

When It’s OK to Lower the Performance Bar

Published by
jones_blair

Blair Jones

On March 3, 2015, NACD in partnership with Compensation Advisory Partners, Farient Advisors, Pay Governance, Pearl Meyer & Partners, Semler Brossy, and Steven Hall & Partners, will host its annual Leading Minds of Compensation event in New York. Here, a collective of the nation’s leading experts will provide their insights on compensation challenges directors need to be attuned to in 2015. In anticipation of this event, Semler Brossy’s Blair Jones and Seymour Burchman explore the perpetual issue of pay for performance. 

When it comes to executive compensation and company performance, directors commonly go by the following “rule:” The goals for the coming year should exceed last year’s results. Some directors believe that, if performance goals decline, executives should not receive any bonus, even if the business environment won’t allow the company to exceed its prior performance record. But the rule that requires companies to always set higher goals for top-line and bottom-line results should not be considered hard-and-fast. Even as companies aim for long-term, continuous improvement, there are legitimate cases when lowering the bar is acceptable.

burchman_seymour

Seymour Burchman

Three situations show that circumstances occasionally dictate the need for lowering performance goals. The first situation is when a company is run by executives who consistently deliver outstanding performance, but in an economic downturn oversee a period of falling results that still top the industry. (This example holds true for virtually any company caught in a major economic downturn.) The second is when a company comes off several years of great results, but executives and the board decide to make major investments to enhance long-term competitiveness, lest competitors catch up. The third is a cyclical commodity-based company that, in spite of best-in-class operational efficiencies and rising sales, gets blindsided by volatile raw-material prices, boosting the costs of goods sold by a third or more.

Executives at these companies should not always be expected to demonstrate year-over-year improvement. Asking them to essentially juice results during a single year might even hurt the long-term success of the business. (Deferring an investment to meet current year profit goals may result in losing ground to competitors in the long term. Similarly, deferring maintenance to reduce current year costs can lead to increased downtime down the road.) That’s not to say directors should accept anything less than a long-term record of sustained, rising results, only that for temporary periods decline may fit within that record.

So what steps can a board take to ensure that year-over-year declines are truly exceptions? First, directors should begin every goal-setting cycle with the simple premise that year-over-year improvement is the standard. Second, if management contends that a decline is inevitable, directors should consider the steps management has been taking to anticipate and mitigate the decline. For example, are there valid strategic reasons for a decline, such as ramping up long-term investment? Can the board reasonably expect, based on management’s plans, that investments will lead to future performance that compensates for the decline?

If external forces are contributing to the decline, the board needs to consider whether management explored all reasonable alternatives to avert the decline. Key questions the board should raise include:

  • If a demand slowdown was forecasted, did management adequately explore new market opportunities to offset declines via new channels, new geographies, or the use of new methods to reach customers (e.g., “big data”)?
  • If raw material costs were forecasted to rise, did management consider hedging increases or consider alternative sources of supply?
  • If competitors have breakthrough product launches planned, did management anticipate these launches, and where possible, accelerate its own development of potential competing products?
  • If manufacturing costs were forecasted to rise, did management either consider reengineering current processes or explore potential cheaper outsourcing solutions?
  • If disruptive technologies were likely to affect the industry, did management position the company to swiftly take advantage?

As part of examining the steps management is taking, the board should also look at its own actions. Key questions the board should ask itself include:

  • Was the board involved fully in the development of this strategy, and did executives make short- versus long-term tradeoffs clear?
  • Have directors demonstrated adequate goal-setting discipline themselves as evidenced by balance and symmetry in their decisions over time?
  • Were unfavorable circumstances that resulted in more lenient goals balanced by favorable circumstances with more aggressive goals?

If the board is to make exceptions to an otherwise universal standard of continuous improvement, it needs to follow certain standards in adjusting goals. It may be that a board can become comfortable in setting lower goals at threshold and target, but maximum goals require truly superior performance.

Third, once the board makes an exception, it should balance the interests of the management team and shareholders. Shareholders deserve to know that directors have set adequate stretch goals to drive superior performance. Over time, goals should result in performance and payouts that meet four tests:

  1. They are sufficient to generate returns above the risk-adjusted cost of capital, and presumably in turn boost total shareholder return.
  2. They align relative pay and performance with peer companies.
  3. They represent a fair sharing between executives and shareholders of the value created.
  4. The rewards are sufficient to keep executives motivated and engaged.

No director takes the lowering of performance goals for granted. Management has the responsibility to develop, execute, and reformulate a strategy to deliver year-over-year improvements. But times come when exceptions are warranted for the long-term success of the company. The aim then is simply to create the most effective way to reward and motivate executives while keeping performance at the necessary level for sustained success.


An executive compensation consultant since 1991, Blair Jones currently serves as a managing director of Semler Brossy Consulting Group. She has worked extensively across a variety of industries and has particular depth of expertise working with companies in transitional stages. She may be contacted at bjones@semlerbrossy.com. Seymour Burchman is a managing director of Semler Brossy Compensation Group and has been an executive compensation consultant for over 20 years. His work focuses on reinforcing key strategies and leading to improved shareholder value through the identification of performance measures and goal setting processes. He may be contacted at sburchman@semlerbrossy.com.

An Update From the SEC

Published by

It is no secret that the Securities and Exchange Commission has been slow to fulfill the rules mandated by Dodd-Frank. As of July 1, the agency had missed over half of the deadlines—56 out of 95 required rulemakings—according to the Davis Polk Dodd-Frank Progress Report. Despite this general lack of news, in late June the SEC released final rules on matters related to the compensation committee to little fanfare.

The rules focus on independence for both compensation committees and their advisors. Companies will now be required to disclose the existence of compensation consultant conflicts of interest and how these conflicts are addressed. Additionally, each national listing exchange is now required to propose heightened standards for independence of compensation committee members and the evaluation of compensation advisor independence. While the style of these new listing standards will be similar to those already existing for the audit committee, the SEC has established that the standards must consider the following two factors:

  • The source of compensation of the director, including any consulting, advisory or other compensatory factors paid by the listed company to the director; and
  • Whether the director is affiliated with the listed company or any of its subsidiaries or their affiliates.

While these rules affect proxy statement disclosures, compensation committee composition and boardroom procedure, they have received little attention. There are many possible explanations for this, including the fact that both the New York Stock Exchange and NASDAQ already address compensation committee director independence to an extent. However, timing is also a factor. The required disclosures of compensation consultant conflicts of interest will be effective for the 2013 proxy season. With respect to the new standards on independence, NYSE and NASDAQ have until Sept. 25, 2012, to propose new guidelines, which the SEC does not have to approve until June 27, 2013.

At NACD’s Compensation Committee Chair Advisory Council meeting in June, SEC Chief Counsel and Associate Director of the Division of Corporate Finance Thomas Kim spoke to the delegation on the SEC’s current activity. In addition to the rules on compensation committee independence, the agency is currently in the process of drafting proposed rules on the required pay ratio disclosure, as well as the “clawback” of executive compensation provision. Similar to the recently released rules, the clawback rules must be proposed and finalized by the SEC, then adopted by the listing exchanges—therefore placing the rules on the horizon, but not in the near future.

At the Advisory Council meeting, a key theme of the discussion was the necessity for boards to create transparent and comprehensive compensation packages. To this end, it was announced that NACD will produce a guide that will help boards develop pay plans to effectively compensate executives and communication strategies that articulate how these plans create long-term shareholder value.

For more information about the guide and the Advisory Council meeting, click here.