Equilar Institute

Staying Above Water

What are the critical issues boards should be prepared to address with shareholders during and after their annual meetings?

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Ms. Jordan’s primary focus is to help Grant Thornton’s clients achieve their most critical business goals, based on a deep understanding of their needs and future aspirations. She leads the firm’s strategic client portfolio of over 1,000 major client relationships as well as the geography, industry, go-to-market, sales and customer experience teams.

As a member of the firm’s Senior Leadership Team and Chair of the Growth Committee, Ms. Jordan led the design and implementation of a firm-wide growth strategy. She works from the client outwards to take an integrated view of how the firm can help clients achieve their most important business goals.

To enable the firm’s growth strategy, Ms. Jordan has helped lead her firm’s efforts to build a truly digital enterprise. Encompassing technology, operations, growth, performance management and finance, Grant Thornton is developing the digital infrastructure to enable their leaders and all professionals to connect closely with their clients and thrive in the workplace of the future.

With the SEC urging transparency and robust disclosures around cyber threats, board members are wise to address cyber resilience: their capacity to function in the event of a cybersecurity incident. While technology drives innovation across a wide range of industries, it also correlates strongly to increased risk. Boards can first prepare for disruption by measuring their resources and culture, educating and engaging employees as a first line of defense. Boards also need policy defining oversight responsibility. Whether through a specific risk committee, their audit committee or the full board, oversight roles and responsibilities must be clearly communicated. Then, if boards haven’t yet made cybersecurity a priority, they must. Whether tapping experts inside your company like a chief information security officer (CISO) or looking at outside sources like a trusted advisor, invite experts who aren’t typically in the boardroom to get everyone on the same page regarding cyber threats and opportunities.

Likewise, boards should plan for disruption from technologies. We’re in the beginning of a multi-year 5G rollout with the greatest wireless speed and capacity improvements and lowest latency in a decade. This will enable the Internet of Things (IoT) to connect devices and systems critically supporting innovation across all industries. With 5G and IoT, data privacy should stay top of mind. Directors must thoroughly understand the risks to profitability associated with stockpiling data. Include a regulatory update on data privacy policy in board agendas, considering compliance costs to avoid a significant competitive disadvantage.

Artificial intelligence (AI) is another disruptor continuing to dominate technology innovation. Board members who only know AI as a buzzword but don’t understand specific solutions need to identify gaps in their business strategy—then decide what AI solutions can (and equally as important, cannot) do. AI will soon be able to recognize, interpret, process and simulate human emotions, which will change the future of work. Boards are smart to understand this inevitable trend and the possibilities it creates in bringing more value to customers, creating a better experience for employees, developing new products and disrupting competitors.

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Ryan Resch is a Managing Director of Executive Compensation at Willis Towers Watson and is based in the company’s Toronto office. Mr. Resch works with boards and senior management on developing compensation and related human resource programs that align with an organization’s purpose, strategy and culture. He works across a number of industries with a focus on energy and industrial organizations. He also leads the company’s initiative on the Future of the Compensation Committee.

Investors, proxy advisors and regulators are increasingly focused on gender diversity among boards and senior management teams, and, in some cases, directly on gender pay related matters. For example, Arjuna Capital recently filed shareholder proposals at 12 large, publicly-traded financial services and technology companies requesting disclosure of their median gender pay gap. This increased pressure has boards asking questions more frequently to demonstrate effective oversight of gender pay-related issues within their organizations. These efforts aim to proactively address shareholder questions and reflect boards’ expanding responsibilities for the oversight of their organization’s human capital.

Gender pay gaps are viewed and reported through different lenses, and it’s important to know how your organization is viewed through each lens. Equal pay focuses on whether you provide equal pay for all employees in jobs of equal value, and is usually analyzed using a multi-variate regression model that identifies the statistically significant predictors of compensation and then determines whether employees are paid outside of the predicted compensation range. A gender pay gap, as articulated by Arjuna’s proposals, and consistent with U.K. gender pay reporting requirements, compares pay provided to the median male and female employee across the organization. Organizations have historically focused on the equal pay analysis, and many larger employers have reported that they provide equal pay for male and female employees. However, gender pay gaps are most predominantly a result of a representation issue where there are more male employees in senior, higher-paying roles. Closing this gap requires more of a gender balance at all levels of the organization. This is only achieved through deliberate talent program changes combined with ongoing review of compensation practices and analysis of pay outcomes.

Boards need to examine a comprehensive review of gender pay analytics across their organizations, recognizing the need to review governance protocols and how this review is conducted. This includes the overall demographic mix of males and females by level, job family and location; median/average male vs. female pay; equal pay analytics; and other tests of potential gender biases within the various HR and compensation programs (e.g., hiring and promotion decisions). Management can then develop strategies to address potential issues across the employee life cycle with regular reporting of progress to the board. The board can then use this information to set a conscious pay transparency strategy that supports regular and ongoing shareholder discussions throughout the year.

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Talon Torressen is Director of Research at Georgeson, specializing in corporate governance consulting. He is focused on ESG, M&A and activism defense practice areas. He is a corporate governance expert with over 12 years of industry experience, which he leverages to provide insights that strengthen Georgeson clients’ understanding of the investor perspective. He also has comprehensive legal, compliance and risk expertise.

Prior to joining Georgeson, Mr. Torressen was Director of Investment Proxy Research at Fidelity Investments. As part the management team, he was responsible for corporate governance analysis and proxy voting 6,000+ companies annually representing equity assets in excess of $1 trillion.

Now that most annual meetings are behind us, it is time to focus on critical issues specific to your company. First and foremost, companies need to analyze annual meeting voting results and identify any issues that they may reveal. Shareholders will be looking to engage with management when voting subsides. Additionally, shareholders expect companies to respond to proposals that attract substantial opposition. Companies should engage with significant shareholders to understand their perspectives and fully disclose their engagement efforts in the subsequent proxy statement.

Next, it is time to evaluate any governance vulnerabilities that did not translate into negative votes this year. During this process it is important to understand shareholder views and expectations on environmental, social and governance (ESG) issues. Once topics are identified and included in your shareholder engagement strategy, it may be appropriate to include relevant board members in the engagement efforts. Last, you can also use your governance vulnerability assessment as a starting point for your activism defense preparedness activities.

Below are some ESG issues to consider that we expect will gain momentum among shareholders.

• Board of Directors — Does the company have a high-performing board?

• Culture — Is there board oversight of the company’s culture? How does it align with company strategy and how is it disclosed?

• Diversity and Refreshment — Does the company consider diversity (including gender, race, age and skills) as part of the board refreshment process?

• Evaluation — How does the company evaluate its board? Could it disclose this evaluation better?

• Overboarding — Are board members sitting on too many boards, given the increasing demands on their time?

• ESG Disclosure and Reporting — It’s important for companies to evaluate their ESG reporting structures and seek shareholder input on the ESG data that they consider valuable.

• Activism Preparedness — As the activism landscape continues to change, it is important to assess vulnerabilities and have an established plan.

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Doreen E. Lilienfeld is Global Head of the Governance & Advisory Group and the Team Leader of the Compensation, Governance and ERISA practice at Shearman & Sterling.

She focuses on a wide variety of compensation-related matters, including the design and implementation of retention and compensation plans, disclosure and regulatory compliance, and employment negotiations with senior executives. She has advised both U.S. and non-U.S. issuers on corporate governance and regulatory requirements relating to compensation and benefits matters, and high profile individuals in their employment and severance negotiations.

For the past 16 years, Ms. Lilienfeld has spearheaded the publication of the Shearman & Sterling survey of the compensation-related corporate governance practices of the largest 100 domestic issuers. She is a lecturer in Executive Compensation at the Berkeley School of Law.

Environmental, social and governance (ESG) issues are a top priority, especially for the largest public companies. While ESG has received much attention largely due to a combination of investor, employee and customer interest, more and more companies are being responsive to shareholder demands for integration of ESG issues into the corporate culture—to be manifested in both business strategy and executive compensation decisions.

Surveys show that many directors and executives believe ESG issues play a large role at their companies. Most say ESG issues are linked to the firm’s business strategy and many say they relate to business goals, value proposition and its competitive differentiation. However, few provide a direct link to compensation and state performance factors are explicitly stated as ESG metrics. We think that is likely to change in the near term if shareholders have a say.

Since the elimination of the performance-based compensation deduction under Section 162(m) of the code, more companies have indicated direct links between executive compensation and ESG goals. For example, safety metrics have long been an element of many executive pay programs in the manufacturing sector. But more recently, several public companies have indicated that specific percentages of compensation will be tied to safety, environmental stewardship, energy efficiency and greenhouse gas emissions, and diversity goals.

Executive compensation can be a powerful tool for advancing business and leadership strategies. For those boards that strongly believe in moving their companies along this continuum and pursuing a deeper operationalization of ESG factors—whether in response to regulation, stakeholder push or the bottom line—incentives may be a catalyst. Incentive goal setting can also be an important tool in communicating priorities. Including incentives based on ESG in your plan signals to all stakeholders—including employees and management—its importance to the company and can spur the process of embedding it into the business and the culture. Boards that are thinking about integrating ESG metrics in their programs and taking steps to advance their progress will stay ahead of the curve.

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Irv Becker is Vice Chairman of Korn Ferry’s Executive Pay & Governance business, based in the firm’s New York office. Mr. Becker partners with boards and senior executives to create sustainable organizations, enhancing the effectiveness of the board/CEO relationship. He works with groups to design and develop reward programs, aligning executive efforts and results with the success of the company.

Mr. Becker’s financial background provides a grounded perspective on performance measurement and management. Since 2008, Mr. Becker has been included on the Directorship 100, a list published by Directorship magazine recognizing the most influential people who shape agendas and corporate governance issues in boardrooms across America.

Mr. Becker has worked with major public and private corporations across multiple industries. His clients range the spectrum from Fortune 50 companies to pre-IPO startups. He has worked with companies involved with initial public offerings, mergers, acquisitions and divestitures, as well as helped organizations develop new reward philosophies and approaches to support a major change in business direction.

Compensation committees are likely to face greater scrutiny in years ahead as shareholders take a more critical view of the metrics and goal setting approaches that exist within their executive compensation plans.

For the most part, organizations encountered little resistance to their executive compensation plans in the most recent annual reporting season. With most companies performing well and market valuations near all-time highs, shareholders generally did not challenge compensation plans—even though many plans were at or near maximum payout.

Looking ahead, three factors are likely to stimulate greater shareholder oversight on executive compensation plans:

• Institutional Shareholder Services (ISS), the world’s largest proxy firm, has developed analytical capabilities to track corporate performance against compensation plan goals. As a result, shareholders will be able to offer more informed input and criticism of financial goals that drive compensation plans going forward.

• ISS will also be calculating and reporting (for information purposes only) Economic Value Added (EVA) for companies it reports on. EVA essentially measures a company’s profit versus its cost of capital. Organizations that otherwise appear to be outperforming their peers, sometimes do not grade well when evaluated by EVA—which could spark shareholders to question the underlying financial stretch of the goals used in the compensation plans.

• After several years of strong economic growth and corporate performance, there’s a high probability that the world economy will slow and company performance will decline. Shareholders will likely object to compensation plans that allow executives to easily exceed target payouts in a recessionary environment.

Given these dynamics, compensation committees should:

• Ensure that they are able to articulate to shareholders how their pay packages align with shareholder interests and promote actions and behaviors that advance the business strategy. Transparency and clarity need to be a top priority.

• Redesign plans that have paid the maximum to their executives several years running so that in the future the plans generate a normal distribution whereby executives achieve maximums about 20% of the time, miss thresholds 20% of the time, and achieve target around 60% of the time.

• Integrate the key metrics that are aligned with the company’s business strategy and be prepared to justify the metrics and the goal setting process associated with them.

In short, by accepting and adjusting to the new reality of increased shareholder scrutiny, compensation committees will be better positioned to create plans that meet the needs of all parties and promote actions and behaviors that drive organizational growth and success.