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Special Report Executive Compensation—HR's Missed Opportunity

May 8, 2008
Related Topics: Compensation Design and Communication, Tools, Benefits
Every time another company gets attacked for how it compensates its top executives, Bruce Ellig asks himself, "Where the hell is HR?"

    Publicly traded companies have never been under as much scrutiny regarding executive pay as they are today. With Congress, the Securities and Exchange Commission and shareholders demanding to know how much executives are making and how companies are disclosing these sums, many organizations are seeking any kind of help.

    It would seem like a golden opportunity for HR leaders to get face time with the board of directors and top management. As experts on their companies’ succession planning and talent development processes, it would make sense for HR to be a key player in talks of how executive compensation is tied to performance.

    But outside of perhaps helping consultants with paperwork, HR is not involved with executive compensation, experts say.

    "Most people sitting in HR have not shown much interest in this area," Ellig says. "Outside of the Fortune 100, maybe the Fortune 250, HR executives are not part of this."

    Ellig has a unique perspective on the issue. From 1985 to 1996 he was corporate vice president of employee resources at Pfizer, where he served as corporate treasurer to the compensation committee and played a key role in helping put together executive compensation packages. He is now an independent compensation consultant and the author of The Complete Guide to Executive Compensation.

    Ellig believes HR’s lack of presence in executive compensation discussions is the profession’s own doing—or not doing. Too much HR training is focused on softer sciences, like recruiting and training, and not enough on the financials behind them, he says.

    "The fact is, the individuals who are comfortable with the touchy-feely parts of HR don’t get turned on by reading the Employee Retirement Income Security Act or the Internal Revenue Code," Ellig says. "But HR should clearly be part of this because we are talking about human capital."

    An indicator of how much HR is sidelined from executive compensation discussions was evident when Workforce Management asked a major executive compensation consulting firm for an interview for this article. The PR contact didn’t understand why HR would care about the topic.

    By not getting involved in executive compensation, HR executives are losing the opportunity to influence company strategy in a key area that they should understand completely: leadership development and succession planning.

    Over the past proxy season, succession planning has been in the sights of such organizations as the AFL-CIO, which has submitted proposals requesting shareholder say in companies’ succession planning processes.

    "Shareholders recognize that a lot of the big pay problems have been associated with failed senior executives who come from outside the organization," says Diane Doubleday, a worldwide partner at Mercer. "The typical pattern is that a company pays an executive a big package to come in and take over and promises to pay them if it doesn’t work out."

    Companies with strong succession planning and leadership development, however, can deflect this problem by promoting from within. But HR needs to help management see this link, experts say.

    "This is something that HR should care about," Doubleday says. "It’s an opportunity for them to push something near and dear to their hearts."

Disclosing performance goals
    One of the biggest executive compensation challenges that public companies face today comes from the Securities and Exchange Commission, which is pushing public companies to disclose how they determine their executives’ compensation. Specifically, the agency wants to make sure that companies tie executive compensation to performance. The agency has required that firms say what performance targets they use—information that many companies are reluctant to release for competitive reasons.

    The SEC’s mandate for companies to disclose performance targets is part of the agency’s new rules on executive compensation disclosure that went into effect last year. However, the agency wasn’t satisfied with many companies’ efforts.

"Outside of the Fortune 100,
maybe the Fortune 250, HR executives are not part of this."
—Bruce Ellis

    Last summer, the SEC sent letters to 350 of them, stating it wanted more information about what performance targets they used to determine executives’ pay. Experts predict that if companies fail this year to disclose this information to the agency’s satisfaction, the SEC may force these firms to refile their annual financial statements. Despite the SEC push, many companies continue to avoid disclosing the information. A survey by Watson Wyatt Worldwide this year found that only 42 percent of companies planned to disclose their performance goals in their 2008 proxy statements.

    It’s not a particularly surprising finding, compensation consultants say.

    "A lot of companies are very concerned about disclosure," says Daniel Ryterband, president of Frederic W. Cook & Co., a New York-based executive compensation consultant. Companies are concerned about disclosing specific performance targets, like market share in a new area or business unit goals, that could reveal their business plans to competitors, Ryterband says.

    "It could set up a whole business plan for competitors to peer into," he says. A number of companies have appealed to the SEC to allow them to keep the information confidential for competitive purposes—with little success, a number of compensation consultants say.

    "The SEC doesn’t always buy the confidential treatment/competitive harm argument," says Deborah Lifshey, a vice president at Pearl Meyer & Partners.

    The unfortunate result, Lifshey says, is many companies are changing their plan design so executive compensation is determined on a more subjective basis rather than solely on objective performance goals that companies have to disclose.

    "Companies are making it so the performance goals they set are easy to achieve, but then the committee has discretion on how it determines the rest of the executives’ pay," she says.

    For organizations taking this approach, HR could be a key player in making sure executives understand how their compensation is being determined, Ryterband says. "Management needs to understand what good performance means," he says.

    But these companies had better prepare to be targeted by shareholders, says Patrick McGurn, special counsel for ISS Governance Services, a division of RiskMetrics Group, a New York-based risk management consultant.

"[Succession planning] is something that HR should care about. It's an opportunity for them to push something near and dear to their hearts."
—Diane Doubleday,
worldwide partner, Mercer

    Companies that didn’t disclose the performance targets last year are the ones that are being targeted with no-vote campaigns, in which shareholders withhold their votes to re-elect the board members responsible for doling out the pay package.

    HR executives can help their companies determine which performance metrics to use, but it can be tricky in the new environment, Lifshey says.

    "Maybe there is a goal that doesn’t rise to the competitive-harm standard, but the company still doesn’t want to disclose it for competitive purposes," she says. "There is going to be a tricky balance between getting the right performance measures from a business perspective and finding metrics that you want to disclose."

HR becomes IR
    During the past several months, a new role has emerged for those rare HR executives who know executive compensation. More companies are relying on them to help them address shareholder concerns.

    McGurn says that in the past several months he has seen more HR executives participate in discussions his firm has with boards of directors about executive compensation issues.

    "Over the past couple of years it hasn’t been unusual for a senior HR professional to be in the room to explain the intricacies of some of the executive compensation arrangements that go beyond the detailed understanding of the board members themselves," he says.

    And as "say on pay" proposals gain traction, having HR available to deflect these votes could be helpful, experts say. These proposals allow shareholders to give a nonbinding vote on executive pay packages. As of April 30, Apple was the only company where a "say on pay" proposal had received majority support, according to ISS.

    There are currently 70 other such proposals that are likely to come to votes at annual meetings this year, according to ISS.

    HR really needs to get in front of the say-on-pay issue, particularly now that legislation on it is pending, Mc­Gurn says. Sen. Barack Obama, D-Illinois, and Rep. Barney Frank, D-Massachusetts, have introduced bills that would force companies to have annual nonbinding shareholder votes on executive pay packages.

    It would behoove companies to deflect such legislation and work with shareholders one on one, McGurn says.

"A lot of companies are very concerned about disclosure. ... It could set up a whole business plan for competitors to peer into."
—Daniel Ryterband, president,
Frederic W. Cook & Co.

    "Right now, management has a lot of flexibility about how they structure their say-on-pay votes, but if there is legislation they will lose that," he says. "Right now HR is a spectator in all of this, but they should be thinking about how they can get involved in discussions with shareholders."

    And this is the prime opportunity for HR to talk about the pressures the company may be feeling with regard to succession planning, says Mark Rosen, managing director at Pearl Meyer.

    "It’s best practice to promote from within," he says. That can mean paying a premium to keep talent from going to the competition, Rosen says. HR should also be playing a key role in preparing executives and boards before meetings with shareholders, experts say.

    "HR needs to prepare the executives and the boards before an annual meeting because executive compensation is always a big topic," says Eric Turzak, a senior consultant in the executive compensation practice at Hay Group, a Philadelphia-based global management consultant. "It’s HR’s job to provide these executives with statistics and research on how their peers are performing and being paid versus what they are performing and being paid."

    This means that HR needs to be able to examine the company’s executive compensation program and figure out what will be an issue for shareholders, Ellig says.

    When he was head of HR at Pfizer, each business division, including HR, would prepare questions that shareholders might pose, as well as answers. All of that material was discussed before the annual meeting.

    "Even if the questions weren’t asked during a shareholder meeting, it exposed the vulnerabilities that we might have and should be discussing," he says.

    Playing this role may be particularly tricky for heads of HR, who will need to walk a fine line between keeping their CEO bosses happy and making sure their companies aren’t going to be embarrassed by outlandish perks or benefits, experts say.

    But again, if HR can make a case for why top talent needs to be retained, and prove it through research and statistics, companies could legitimately defend some perks.

    "One of the biggest challenges for HR is retaining talent," says Steve Van Putten, executive compensation practice leader for the Eastern region at Watson Wyatt. "And most of the best talent is migrating to go work at hedge funds and private companies."

Consultant conflicts
    While companies are scrambling to deal with SEC rules and increased shareholder activism, many now are also looking for new compensation consultants because of increased congressional scrutiny.

    In December, Rep. Henry Waxman, D-California and chairman of the House Oversight and Government Reform Committee, released a report citing "pervasive" conflicts of interest among compensation consultants that help companies with executive compensation and other matters. In 2006, the median CEO salary of the Fortune 250 companies that hired compensation consultants with the largest conflicts of interest—that is, those that had significant other consulting business with the companies—was 67 percent higher than the median CEO salary of the companies that did not use "conflicted" consultants, according to the report.

"There s going to be a tricky balance between getting the right performance measures ... and finding metrics that you want to disclose."
—Deborah Lipshey, vice president,
Pearl Meyer & Partners

    Until now, most companies have trusted the fact that their compensation consultants kept executive compensation separate from other consulting activity to avoid a conflict of interest. While that might be true, companies are less comfortable now with a single consultant relationship and many are looking to hire a separate consultant strictly to do executive compensation.

    Many firms are asking their HR executives to come up with a shortlist of boutique firms they could hire to handle their executive compensation business, experts say.

    HR’s role may be increasingly complicated in those companies that have retained one consultant to help design and implement rank-and-file compensation programs and another that reports to the board and deals only with executive compensation, McGurn says.

    It will be up to HR to make sure that executive compensation and overall employee compensation are aligned, even though the company is using separate consultants, McGurn says.

    "Shareholders want to see alignment run throughout the organization," he says. "HR will have to make sure that happens."

    While sensitivity to executive compensation might be more acute today because of the economy, this issue isn’t going to die down anytime soon, experts say. And it’s up to HR executives to decide if they want to get involved, or be sidelined forever, experts say.

    "HR executives are feeling the pressure," says Mark Reilly, a compensation consultant based in Chicago. "CEOs are saying, ‘If you can’t help us with this, we will find someone who can.’ "

Workforce Management, May 5, 2008, p.1, 20-26 -- Subscribe Now!

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