Executive compensation has been one of the most widely discussed issues for shareholders in recent history. Pay for performance is the mantra of shareholders and investors; the issue of a material disconnect between pay and performance has always been at the heart of executive compensation and a real area of contention for shareholders and investors. An improperly compensated executive can cost shareholders financially and can lead to a misalignment of the interests of executives with those of shareholders and investors.
The pandemic – an economic crisis like no other – has enveloped the entire globe and changed it permanently. It therefore becomes central for companies to effectively address shareholder and investor concerns about a misalignment on pay for performance, and there are several ways this can be achieved.
Communication: If issuers want to formally address investors’ concerns on pay for performance, they should endeavor to start engagement with their shareholders early – specifically, as soon as their board makes the decision on management's emoluments, to ensure investors understand that investor concerns are also of primary interest to the firm.
Ensuring an engagement between executives and shareholders permits a discussion about crucial corporate governance issues that are at the forefront of shareholders’ minds. Regular communication with shareholders is key to maintaining shareholder confidence during such a fraught time.
Transparency: Companies should work actively with their compensation consultants to ensure their remuneration policies are as transparent and concise as possible. Companies that are embracing the demands of greater transparency to shareholders are more appropriately acting in the interests of shareholders. It has become more important than ever to ensure good governance through engagement and transparency between shareholders and boards.
ESG: Remuneration committees recognizing that they have a role to play in addressing urgent challenges concerning ESG will enhance a company’s long-term performance. The level of interest in this area will only continue to increase, as investors and shareholders put pressure on companies for a strong commitment to ESG. Over the course of 2020, companies that placed a premium on the environment, society and good governance often outperformed their peers, according to BlackRock chief Larry Fink’s 2021 letter to CEOs.
Compensation committees: Issuers should embark on a peer review to benchmark their remuneration policy with a customized peer or their sector of operation. It is critical to ensure that a company’s executive pay reflects its performance and aligns with the market. It is essential for companies to have an appropriate peer review for performance benchmarking, compensation program design and other compensation decisions.
In order to maximize the effectiveness of compensation committees, there are a few things members can do:
- Be aware of the role you are playing in representing and advising the board on executive pay
- Ask questions – this is important as it enables a greater understanding before coming up with solutions
- Make decisions from an informed position, considering all factors such as competitive data, market conditions and company and executive performance
- Ensure you have a good working knowledge of pay and benefits practices.
While every company may do things differently, one point above all else is true: it is the misalignment of pay and performance that can ultimately decide whether a company is a best-in-class firm. The companies that effectively address and rectify shareholder and investor concerns about a misalignment on pay for performance will be those delivering long-term success to shareholders and investors.
Dottie Schindlinger is executive director of the Diligent Institute.
This article was originally published in the Fall 2021 issue of IR Magazine. Click here to access the magazine.