While setting remuneration policies for the organization’s top executives is still job number one, compensation committees are increasingly playing a greater role in overall human capital management issues, from pay equity, diversity, and talent development and retention to helping ensure that performance incentives throughout the organization are aligned with the company’s culture and strategy.
Investors are looking for clear disclosure of how compensation incentives align with the company’s purpose and strategy for long-term value creation, and how the company has responded to shareholder concerns regarding pay, diversity, corporate culture and purpose, and other pressing environmental, social, and governance (ESG) issues. With that as a backdrop, the following considerations may be helpful for compensation committees as they explore extending their oversight responsibilities beyond executive compensation to include human capital management and social issues.
Review the committee charter against its current oversight activities and consider whether changes are necessary. An increasing focus on intangibles such as talent and human capital, continued scrutiny of CEO and employee pay, and the potential risks posed by incentives all are driving boards to rethink the scope of the compensation committee’s responsibilities.
A KPMG analysis of BoardEx data found that roughly 200 S&P 500 companies have compensation committee titles that reflect human capital issues, for example, “compensation and human resources committee” and “compensation and personnel committee.” Changing the committee name sends a strong message about the committee’s focus and the board’s priorities, but a new name is only meaningful if it aligns with the committee charter and annual work plan. To that end, compensation committee members should review and update the charter and work plan to reflect the committee’s current scope of responsibilities, and integrate any new responsibilities into committee meeting agendas.
Consider whether to incorporate nonfinancial or ESG metrics into executive compensation plans. As investors continue to call for a stronger link between executive pay and company performance, nonfinancial metrics—including those related to ESG activities—are increasingly supplementing traditional performance measures. According to CEO and Executive Compensation Practices: 2019 Edition by The Conference Board, 71 Russell 3000 companies included ESG-related performance goals in 2018.
Given the Business Roundtable’s Statement on the Purpose of a Corporation, we can expect investors to continue to focus on how companies integrate ESG into executive compensation—e.g., pay linked to climate change resiliency, human capital management, and diversity and inclusion. As with other nonfinancial metrics, any ESG metrics included in compensation plans should be material, measurable, and linked to the company’s strategy.
Understand how incentives drive behavior—and the associated risks— down through the organization. Is pay driving too much risk taking or the wrong behaviors? What is going on further down in the organization in terms of incentives and pay-driven behaviors? A formal risk assessment of compensation incentives throughout all levels of the company can help determine whether incentives are working as intended. If the compensation committee and board are requesting this type of report, it sends a message to management about the board’s expectations.
Leverage disclosures and shareholder engagements to tell the company’s compensation story and address concerns. It is increasingly important for compensation committees to clearly explain the link between their pay policies, corporate strategy, and purpose. Shareholders, proxy advisors, and other stakeholders will also be looking for an explanation of how compensation is linked to ESG risks and initiatives, the policies the company has implemented to address pay inequality, and the company’s human capital management initiatives. Directors should be well versed in the facets of pay that are of greatest concern to shareholders so that they can discuss them during engagement meetings, which should be scheduled proactively and well before proxy season begins.
While these issues will command time and attention, the compensation committee’s primary responsibility, executive compensation, remains unchanged.
This article originally appeared in the May/June 2020 issue of NACD Directorship magazine.