Radford Perspectives

Executive Compensation

Discover the biggest executive compensation trends and challenges facing technology and life sciences companies today.

In today's highly competitive hiring environment, the role of the board and the world of corporate governance and executive compensation is increasingly complex. From our viewpoint, there are three key trends every director should pay particular attention to:

Talent
Development

Boards are asking more questions of the C-suite about talent development further down in the organization as analytics capabilities allow companies to more accurately measure the value of top performers at every level inside the business.

Compensation
Plan Design

Compensation committees are experimenting with new incentive plan designs to keep pace with the market and stand out as truly differentiated all while satisfying various stakeholders. Additionally, the gender pay equity movement makes it critical for boards to ensure there is fair justification for differences in executive pay.

Governance
Policies

Corporate governance issues continue to dominate board work and are increasingly relevant for the compensation committee. These issues range from new proxy advisory regulations to a recent court ruling that has implications for board of director pay to the results of the first year of CEO pay ratio disclosures.

Boards Play the Role of Talent Coach

While CEO succession planning has always been a vital function of the board, many of our clients are becoming more involved in talent development below the C-suite. It’s not uncommon in this competitive labor environment for boards to ask questions of senior executives about the talent pipeline and development at the vice president and even senior director level to identify up-and-coming executive talent. Boards are recognizing the impact high-potential employees have on an organization's success and want to ensure there is an effective plan in place to retain these individuals and develop their career.

Technology and life sciences companies rank leadership development and assessment as a high talent priority for 2018, according to the latest Radford Talent Pulse Survey.

While up-and-coming leaders need to be digitally savvy, the skills they should possess to be effective are increasingly less technical and trend toward business acumen, excellent communication and the ability to think strategically. These skills are ones that the board is well-positioned to identify and assess, irrespective of whether future leaders come from finance, marketing, sales or technical departments. All of this makes the board’s role in the talent development process more relevant and critical.

Figure A highlights some of the ways leading boards are getting involved in talent management. While we see this happening more often at larger companies it is also important that smaller and mid-sized companies think about their talent management strategy as it can provide better oversight and lead to more favorable retention outcomes.

Figure A
CHROs and Heads of Talent List Their Top Five People Priorities

  Commercial Life Sciences Companies Public Technology
Companies
1 Talent Acquisition Talent Acquisition
2 Engagement & Culture Engagement & Culture
3 Talent Assessment Leadership Development & Assessment
4 Performance Management & Development Talent Assessment
5 Leadership Development & Assessment Total Rewards

Source: 2017 Radford Talent Pulse Survey

 

How Can Boards Get Involved in Talent Management?

  • Review talent and development plans for executives at the next two to three organizational tiers below the C-suite to develop a clear understanding of bench strength, timing and potential hiring needs
  • Seek opportunities to meet and engage with upcoming leaders in those next two to three tiers
  • Assess the likelihood of retention for executives and the next two to three tiers down
  • Be aware of the organization’s broader performance management process  
  • Be aware of the organization’s talent management resources and processes
  • Be aware of employee turnover trends and discuss relevant concerns with executives

Reimagining Equity Design

Effective compensation plan design is core to maintaining a company’s culture, particularly in the technology and life sciences sectors where equity ownership remains a defining feature at most firms. Getting the design of incentive plans right is not just about paying your executives enough, it’s about paying them in the ways that drive appropriate performance, reinforce your culture and lead to better engagement for all employees. We advise our clients to always be mindful of ever-changing corporate governance best practices, while still looking for ways to design programs that meet the unique needs of their organization.

Case in point, performance shares continue to rise in popularity at both technology and life sciences sector companies. As illustrated in Figure B below, we observe an overall increase in performance-based equity plans across most key industries.

Figure B
Prevalence of Performance-Based Equity at Software Companies

   

Source: 2017 Radford Performance-Based Equity Report

Note: Smaller companies defined as $500 million or less in revenue; larger companies are greater than $500 milllion in revenue

 

While companies continue to replace or supplement their stock options and time-based full value shares with performance shares, we are also working with a growing number of clients interested in reexamining how their performance shares work. This includes redesigning the metrics and goals underpinning their performance share plans and rethinking whether performance shares still meet the goals of their executive compensation plan.

Several factors are driving this review, including:
 

The US tax bill that passed at the end of 2017, which eliminates 162(m) deductibility for performance-based equity; this could free up organizations to use different forms of equity, especially if they were already considering a change

Difficulty in designing performance shares with metrics that give executives true line-of-sight

Overly complex performance share plans that nobody in the organization truly understands

A sense that the pendulum has swung too far toward performance-based equity plans tied to relative total shareholder return (TSR) metrics

Last year, we also discussed interest from some companies in the UK and US to return to restricted stock with longer holding periods (see our article, In the UK and US, Performance Share Plans Appear Due for a Makeover, for more information). We believe there will continue to be interest from a small but growing number of companies to take bold steps in this regard. Interestingly, research from the 2017 Radford Performance-Based Equity report found that life sciences and software companies with TSR-based performance share plans have not outperformed those companies without such a plan in the market over the past six years. This type of research adds to the argument that TSR-based performance plans don’t always lead to better performance outcomes despite being widely supported by shareholders.

A competitive talent market has some boards designing truly unusual compensation plans. Tesla made headlines recently for its new compensation agreement with CEO Elon Musk. Musk stands to earn $55 billion in company stock if Telsa’s market cap reaches $650 billion— a goal seen as more than a stretch at this point. If Musk fails to reach certain market cap, revenue and profit goals along the way, he receives nothing for those pay periods. What’s more, Musk is required to hold shares for an additional five years after they vest, which prevents him from gaming the system by propping up the stock price for the short-term. While it’s tempting to ignore Tesla as an unusual case unlikely to spark a real market trend, the CEO and founder of Axon requested a similar plan only weeks later.

So perhaps, compensation plans similar to Musk’s (but maybe on a less grand scale), could become more popular, but they certainly aren’t for every CEO or company. They require a certain appetite for risk and confidence in the long-term growth of the company—and, oftentimes, a level of existing wealth that shields an executive from potential downside. We’ve also seen more willingness on the part of proxy advisory firms to consider different types of incentive plan design, particularly in the technology and life sciences sectors that have historically departed from general industry standards in their equity practices.

A Prediction

Innovative and experimental executive compensation plans will become more commonplace as boards and senior leaders test the waters, free from the limitations 162(m) may have imposed before.

 

Corporate Governance Trends:
Pay Ratios, Director Pay and Proxy Advisors

A variety of new corporate governance policies and trends will keep boards busy this year. It's the first year of CEO pay ratio disclosures; a new Delaware court ruling could change the way director pay is structured and approved; proxy advisory firms have new policies impacting their assessment of executive pay; the gender pay equity movement will continue to be influential from the lowest job levels to the C-suite; and investors are filing new types of proxy proposals that target executive compensation, such as preventing share buybacks from boosting CEO payouts.

We'll have a better idea of how CEO pay ratios are being received by various stakeholders, including investors, employees, proxy advisors, the media, and others, as proxy season progresses. However, boards shouldn’t underestimate the constituents who will pay attention to these ratios. Many companies have become more proactive in addressing pay inequities in their organization, and while we don’t believe the CEO pay ratio has anything to do with whether pay is fairly determined within an organization, some stakeholders may point to this figure in justifying their position on internal pay equity (whatever it may be).

We advise companies to discuss their CEO pay ratio in the context of their peers. In doing that, it's important to recognize the influence that industry, company size and growth stage (particularly for life sciences firms) have on pay ratio outcomes. See our article, In Calculating Your CEO Pay Ratio, Relativity to Peers is the New Math, for more information.

Meanwhile, we reported on a new director pay lawsuit that the Delaware Supreme Court refused to dismiss at the end of last year. We’ve had some clients ask about whether they should revert back to separate director compensation plans that contain limits every couple of years, and have shareholders vote on the director pay plan separately. That could be a viable option for companies that want to take a risk-averse approach.

Regardless of whether you want to separate director and executive compensation plans, we recommend all boards take the following steps in light of the court ruling:

Three Steps Boards Should Take to Address Director Pay

  1. Review how your company currently assesses director compensation to determine whether a change in your processes to narrow the scope of director discretion is called for. This can include requiring narrowly tailored (or absolute) annual limits to director equity grants.
  2. Determine whether a fixed share and/or fixed value approach to regular annual director equity compensation grants is warranted.
  3. Consider benchmarking director compensation amounts and designs relative to direct peers, industries and indexes to determine if any of your current practices are outliers.
 

Lastly, we urge companies to closely monitor the effect of updated voting recommendation polices from proxy advisors Institutional Shareholder Services (ISS) and Glass Lewis. While these firms update their voting guidelines each year, it isn’t always clear what impact executive compensation policy changes will have on Say-on-Pay voting recommendations until proxy season is well underway.

There is an exhausting list of corporate governance items to stay on top of in 2018, but boards that are proactive and ask the right questions of experts both inside and outside their organization, will be far better positioned to avoid an adverse outcome (e.g., a negative Say-on-Pay vote or the target of a lawsuit or shareholder activism campaign). For now, there are two policies that we are paying special attention to.

Institutional Shareholder Services (ISS)

  • ISS is adding a secondary quantitative filter under its CEO Pay-for-Performance Policy, which is used to assess Say-on-Pay voting recommendations.
  • The threshold for a “medium” level of concern for S&P 500 companies will be reduced to 2.00 times the median pay of the peer companies, from 2.33 previously. This may result in more qualitative assessments during the 2018 proxy season.
  • ISS will also smooth beginning and ending stock prices used in calculating TSR (we view this as a good thing) as well as run its three existing quantitative tests. The relative pay and performance metrics will be used as a secondary screen.

Glass Lewis

  • Glass Lewis will now expect boards to respond whenever 20% or more of shareholders vote in opposition to a proposal at an annual meeting (compared to its previous threshold of 75%), particularly in the case of director elections, Say-on-Pay and other compensation-related proposals.
  • If a company receives less than 80% support, the firm will expect disclosure in the next proxy statement discussing a post annual meeting shareholder outreach effort and what, if any, actions were taken in response to any perceived shareholder concerns.
  • Absent such disclosure, Glass Lewis could issue adverse vote recommendations for relevant board members and/or proxy ballot items.
 
 

Meet Our Authors

Ted Buyniski
Partner, Executive Compensation Practice Co-Leader

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Edward J. Speidel
Partner, Executive Compensation Practice Co-Leader

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Ram Kumar
Associate Partner, Executive Compensation

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Nora McCord
Associate Partner, Executive Compensation

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Carl Schmitt
Associate Partner, Consulting

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