Executive compensation
tenures falling, this difficult discussion is becoming more urgent. In a volatile and uncertain market, there is more pressure on CEOs to perform at a time when strategy may be shifting quickly. From a compensation perspective, this raises complex issues. For instance, compensation committees must sensitively negotiate pay packages if an external candidate is chosen, even if there are fewer issues with internal promotions. Rewarding those who may feel overlooked is essential for retaining key executives. However, there is also a need to consider new proxy adviser rules requiring clear and descriptive disclosure of the reason for termination of a CEO, which is impacting not only the characterisation of CEO departures but also the structure of their exit packages.
“The rule has the objective of enforcing good pay practices and identifying what counts as retirement,” says Paulin. “If you retire, you leave voluntarily so you should not get severance but there are multiple considerations. Perhaps termination is mutually agreed at board level, but if retirement is what is agreed in that way, then it is now harder to make a deal.” The aim is greater transparency around CEO departures. However implications thus far are, there is an increase in executive chair roles to help with transitioning, succession or consulting agreements where CEOs stay on in some capacity.
“This is beneficial for the business case and there is an actual exchange of services, so this is not the golden goodbye of yesteryear,” says Isakson. “Those days are done.”
The new face of good practice in compensation
Paying severance, accelerating outstanding equity that does not otherwise qualify for retirement treatment or making other negotiated payments to recognise long service upon voluntary retirement are now considered bad practice. They are likely to lead proxy advisers such as Glass Lewis and ISS to vote against recommended compensation packages in public company say-on-pay votes. So how can companies get these packages right?
“If you describe the termination as a retirement and you pay severance or provide value in the form of how equity is treated at retirement, or if you deviate from regular policy on equity treatment, they will vote against you,” stresses Paulin. “For the CEO, retirement is one thing, but being let go even by ‘mutual agreement’ has potentially negative connotations. So, there are more deals around transitional services, consulting agreements and restrictive covenants.” Similarly, describing the reason for termination as involuntary, without cause to justify severance and other payments, is also becoming more prevalent. The connotation with retirement is that people are ready to
Chief Executive Offi cer /
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step down and take another job, but the complexities are significant because of how compensation programmes are structured. Pay for performance has replaced pension plans with equity compensation, and that must be continued or accelerated. But should the award reflect the total value or be prorated for the amount of time worked during the remaining earnout and vesting succession periods? “You can get into trouble if awards are altered when a CEO decides to leave, so it is an important piece to get right,” says Isakson. “The biggest component in executive compensation programme design is the termination-related treatment of equity. But there is also an education piece around good planning. If a CEO retires tomorrow, you need to plan in terms of the treatment of equity and disclosure.”
Mastering the onboarding process The final piece of the puzzle is how to find the right pay model for an external CEO appointment, given that such a move will have repercussions among the existing team. “Generally, our experience as compensation consultants is that boards overpay when they go outside and underpay when they promote,” observes Paulin. “If hiring externally, companies should follow our model, which starts with making ongoing pay, salary, annual target bonus and long-term incentives consistent with the hiring company’s existing pay philosophy and practices for internal equitability across the company.”
If recruiting an experienced person from another public company, then the value that individual is forfeiting at the other firm also must be bought out. Paulin describes this as “making them whole” – so they are no better or worse off than they would have been. This means matching the form and timing of payments as closely as possible. Also, hiring companies and their boards must realize that the risk is on them if they make a mistake, as candidates view the forfeited values as a right if they stay in their current positions, and will generally expect full acceleration upon an involuntary termination in the short term.
“Then you have to provide an inducement to get them to come,” Paulin adds. “If you hire a COO to be a CEO, then the promotion might be enough inducement. With hiring an existing CEO, the inducement may be to work at a bigger company or for better compensation. Big inducements are understood by proxy advisers, but they want them to be long term and performance related.”
Fairness, keeping in line with market practice and balancing the requirements of a new appointment with the need to retain key members of the leadership team are all essential, here. Change may be constant, but it always requires a new and highly specific plan. ●
George Paulin, Partner, Meridian
Compensation Partners
Matthew Isakson, Partner, Meridian
Compensation Partners
“It is about matching up what is good for the company and what is good for the CEO.”
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