By: Paul R. Dorf, APD, CRI

Upper Saddle River, NJ – April 19, 2012 – Another salvo has been fired in the growing conflict between Boards of Directors and their executives, and the shareholders that invest in their companies.  Although the right has existed for a long time for shareholders to attempt to register their dissatisfaction with the executive compensation arrangements in place, the Dodd Frank Act has made it much easier to do so, by mandating their right to a non-binding vote, which can occur as frequently as once a year.

The institutional shareholders of Citigroup recently voted their disapproval of that Company’s executive compensation program, citing that it did not adequately tie the executives’ pay to the bank’s performance.[1]  Of the shareholder votes made public to date, approximately 10% have been vetoed, which supports the concept that shareholders are concerned about the need to appropriately justify executive pay, and that those compensation decisions must clearly be substantiated by improvements in company performance and increased shareholder value.

We believe that there are at least five (5) action items that Boards and their Compensation Committees should address in order to better align their executive compensation programs with the competitive marketplace, and at the same time be responsive to the demands of their shareholders.  These items are not only specific to publicly-traded companies, but reflect best practices for any incentive plan designs:

  1. Review their incentive plans, equity arrangements, and other pay practices to ensure they pass a simple “sniff test”.  In other words, are there any aspects of the plans that are questionable?  Do the plans provide sufficient checks and balances to preclude awards that are not justified?  Are the goals sufficiently aggressive to warrant the payment of the incentive?  Are those goals worth paying for?
  1. All incentives should contain “Circuit Breakers” that set a minimum level of acceptable performance that must be reached before any awards can be paid out.  These can consist of both financial and operational requirements, which prohibit any payments when the company’s performance, finances, or other key indices are in question.
  1. All plans should provide the company with the ability to reclaim paid-out awards, if it is determined that these awards should not have been granted, based on later information.  These are referred to as “disgorgement” or “clawback” provisions, and they are required by specific regulations for publicly-traded and not-for-profit organizations.
  1. In addition to considering achievement against the company’s own goals, it is appropriate to also compare its performance against that of its competitors.  This takes into consideration the old refrain: “A rising tide raises all boats”.
  1. It is a well-known fact that compensation is like physics: one action causes another reaction.  Therefore, incentive plans must be carefully analyzed in relationship to the “Law of Unintended Consequences”, which should identify and preclude any future questionable issues.

By addressing these items, Boards and their Compensation Committees provide a commitment to their shareholders to continually monitor their executive incentive plans and their alignment with a performance-based philosophy.  Ultimately, a certain degree of comfort should be achieved with the overall process for determining incentive plan payouts that directly link to the level of achievement of performance metrics.

[1] The Wall Street Journal, April 18, 2012, “Citigroup Investors Reject Pay Plan”, Page 1.