Compensation Committee: Driving Long-term Value Creation

In 1993, the National Association of Corporate Directors (NACD) issued its first Blue Ribbon Commission report, choosing the topic of executive compensation and emphasizing “pay for performance,” a term that would become a key goal for today’s compensation committees.

One decade later I was privileged to chair a new commission on executive compensation and the role of the compensation committee. At that time, executive compensation packages were receiving extensive political and media attention, and trust in boards of directors, executives, and even the free enterprise system was low. Compensation plans were overly complex and often difficult for the average reader to comprehend. To support compensation committees in bolstering public faith in capitalism, we recommended five principles: independence, fairness, linkage to performance, long-term value for shareholders, and transparency.

Dramatic changes have occurred since the 2003 report. As a result of the 2010 passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (hereafter referred to as Dodd-Frank) and additional rules related to compensation disclosure, there is an even sharper focus on the work of the compensation committee. Some of the changes have been positive: public company compensation committees today are composed entirely of independent directors who are working with a higher degree of accountability than ever before. And although received with mixed reactions, say on pay has led to stronger links between pay and performance, and has even improved board-shareholder engagement.

Yet despite this progress, many issues remain the same. Executive compensation is subject to harsher criticism and more stringent regulation—often focused on the absolute level of total CEO pay, which continues to grow in a booming stock market. Transparency and simplicity in compensation plan design has remained elusive (for supporting evidence, read the often lengthy compensation analysis and discussion section of any proxy statement). While say on pay has brought the aforementioned positive consequences, the desire to gain shareholder (and proxy advisory firm) approval of pay plans may encourage some boards to adopt plans that value short-term gains over long-term value creation.

The compensation committee has transitioned to a position of significance. Of the many responsibilities shouldered by boards, executive compensation may well be the most important and the most challenging. Through pay, boards can attract and reward the talent needed to lead the company into the future. Compensation plans communicate not only what goals the company wants to achieve but also how it wishes to accomplish them.

With several major regulations mandated by Dodd-Frank  yet to be finalized—including those related to disclosures of pay for performance and pay ratios, and policies regarding clawbacks and hedging—uncertainty looms. We do know that the scrutiny on—and expectations of—compensation committees is not expected to decrease in the near future. 

There will be continued emphasis on the work of the committee, including linking pay to performance, selecting appropriate performance metrics, communicating pay philosophy and plans, and the composition of the committee itself. In the future, the caliber and composition of the compensation committee will be critically important, as these are essential aspects of committee effectiveness.

In light of the shifts seen over the past decade, the core concepts identified by the 2003 commission still hold true. This commission expanded the scope of our discussion and developed the recommendations found throughout this report to support compensation committees as they fulfill their evolving responsibilities in an environment of greater transparency and greater complexity.