Compensation Committees and Goal Setting - NACD BoardVision
This episode of NACD BoardVision examines the expectations that boards face when setting annual compensation goals. Christopher Y. Clark, publisher of NACD Directorship Magazine, and Kelly Malafis, partner at Compensation Advisory Partners, discuss best practices for rigorous goal setting.
>> Christopher Clark: Hi. I'm Christopher Clark, publisher of NACD Directorship Magazine and this is Board Vision. Today's topic is going to relate to compensation companies and goal setting. And I'm happy to let you know that I'm joined today by Kelly Malafis of Compensation Advisory Partners, who is also a supporter of our leading minds of compensation event back in March. Kelly, welcome.
>> Kelly Malafis: Thank you. Thanks for having me.
>> Christopher Clark: We talked a little about the rigors of a compensation plan, and I know there are internal and external expectations. Tell me about that effect and what's most important.
>> Kelly Malafis: A you know, goal setting is a process that comp committees go through annually, and they spend a lot of time trying to get it right. And it's a delicate balance between shareholder expectations and what management believes they can get done in a given year. And one way that we help our clients and advise committees to think about goal setting is let's look at it both from an internal and external perspective. From an internal perspective, it's helpful to talk about how does our goal relate to prior year actual performance? Are we growing? Are we flat? What is the rationale behind that level? Also, from an external perspective, what is the industry and investment committee expecting us to do? Again, is everyone growing and we're staying flat? Or are we growing at a faster pace than others, and so we can expect ourselves to do better? And finally, looking at what your peer companies are doing, how have they done historically? And what -- do we expect that trend to continue, and are we following that trend? At the end of the day, having that information helps inform if the goal is rigorous enough. We may be different than what the analysis is saying, but as long as the goal aligns with the business strategy, and we understand why we set it at that level, you'll be in a good place.
>> Christopher Clark: Kelly, I understand that your firm has done some special research recently, and I think if you share with us some of the highlights, it might speak to those 3 points you just talked about.
>> Kelly Malafis: Sure. So a lot of questions that compensation committee members have are around did we get the goal setting right? And we would all like to have a crystal ball to tell us that we -- what the future's going to look like, but we don't. And so we look to see across 100 large companies, how did those companies pay their annual incentive as percent of target over a 5 year period? So we wanted to look at over a multi-year period. And when we looked at those companies, we found that about 70 percent of the companies have what we call goal attainment plans, where there's a traditional target, maximum, and threshold in those plans. And we wanted to see how did they pay out relative to that, target, threshold below target, or maximum. And what we found when we looked at these companies over the 5-year period is that about 10 percent of that time, over this timeframe, there were zero payouts. Thirty percent of the time, there were payouts between threshold and target, 45 percent of the time, there were payouts between target and maximum, and about 15 percent of the time, there were payouts at maximum. So what we see over the 5-year period is a variability. Less on the extremes, so 10 percent and 15 --
>> Christopher Clark: -- Of course that's where the 15 percent gets into the newspapers.
>> Kelly Malafis: Sure. Right. You have -- well, you need to have the support of why you paid at the 15 percent. And compensation committees are happy to pay at maximum if there's performance to support that. But if you're paying maximum 3 years in a row, that should be sign, a signal that perhaps we're not getting it right. Especially because as we look over -- across companies and over time, there is this variability. So you want to see some ups and downs over time.
>> Christopher Clark: Kelly, I'm going to turn this around a little bit. We were speaking of targets but compensation committee members are targets. The utmost of scrutiny, they've taken the mantle away from audit committee members in terms of reputation and scrutiny. So I'm going to ask you this. When these calibrations go awry, when things get a little screwed up and there's not alignment, clearly, the reputation takes a hit. But there are other risks. And do you think the biggest one is retention of key executives?
>> Kelly Malafis: Well, I think that retention is clearly a risk. If the goals are too difficult or unachievable and the executives feel that they cannot achieve them, and there are zero payouts for multiple years, you run the risk of losing your employees because there isn't that alignment between their behavior and activities and the incentive compensation plan. So that's clearly a risk that has to be taken into consideration in the goal setting process. On the flip side, committee members are also concerned with the external risk. If there's a perceived misalignment between pay and performance, again if we're paying at levels above the supported level of performance, that can be viewed in a negative way by shareholders, and can invite scrutiny by proxy advisory firms. And in the stay and pay environment, committees do not want to draw that kind of attention. So again, it's a balance between how do we motivate our executives and retain them through a goal based incentive plan, but also pay appropriate with the level of performance to satisfy the shareholders from an external perspective. So it's really the combination of the 2, I would say.
>> Christopher Clark: Well, Kelly, thank you. On behalf of NACD and Compensation Advisory Partners, I'm Chris Clark, and this is Board Vision.
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