Wednesday, February 18, 2009

How to run a Compensation Committee

In addition to running my own board meetings, I am active on two public board compensation committees (one of which I chair) and I've come to realize that what goes on in these meetings is often not well understood - and needs demystifying.

The Compensation Committee - I'll call it the CC from here on - is responsible for all aspects of compensation in the company, and in particular for executive compensation. This means putting the programs and guidelines in place for general employee compensation, and determining and reviewing specific executive compensation.

Running an effective CC is a partnership between the HR team who prepare the programs and models for discussion and the CC members. A CC typically has a chair and two other members - all three should be independent directors - and often the board Chair and other interested board members will sit in and participate.

There is a tremendous quantity of material that the CC has to review and so there are a couple of keys to setting the CC up for success:
First set up an Annual calendar and make sure all major areas of responsibility are covered at least once a year.
- Committee charter
- Employee compensation and benefits programs: base pay guidelines, stock option guidelines, health benefits, ESPP etc.
- Annual bonus program and the company objectives the bonus program is going to be paid against
- Executive compensation: base pay levels, option and RSU levels, objectives and annual bonus
- Executive promotions: discuss and review with the CEO
- CEO compensation - this is often proposed by the CC but finally approved by the board
- Board compensation: Cash and stock compensation plans for board members, the chair and committee members
- Peer group: What other companies does the CC use to compare compensation levels against to make sure the company's compensation is fair and competitive
- Stock plan, stock pool requirements, overhang levels etc.
- CD&A preparation and review
- Committee self assessment
- Plus any number of administrative items that come up through the year

Because there is such a quantity of material to consider and programs to review it's important to run the CC meeting in a very organized and transparent way. Make sure every board member is always welcome, ensure that every member of the committee has a chance to speak and contribute and that management and the HR team are also given plenty of opportunity to express their views. And make sure that the minutes of each meeting accurately reflect what's been covered since they are the legal record of the meeting.

Also, because executive compensation can be very contentious both with employees and with shareholders it is important to make sure the CC is getting good advice on the latest laws, what other companies are doing, and what the latest shareholder concerns are for your type of company. This usually means hiring an outside consulting firm that specializes in compensation and that consults only to the CC and not to the company. This is an important distinction - that way the consulting firm is never conflicted by wanting to curry favor with management because they may not consult to management while consulting to the CC. This is not a hard rule - but I think it's good business practise to separate out the advice the CC gets from the advice management gets.

And finally, make sure management gets the materials out enough in advance that the committee members can prepare. As the CC chair this usually means I am prepping with the management team and the consultants well in advance so when the materials go out a week in advance they are complete are cover the topics we need to cover.

Monday, February 9, 2009

Companies stop giving guidance - is this a good or a bad move?

In the world of running a public company one of the critical skills a CEO/CFO team used to have to have was the ability to set guidance for the "Street" - that is the sell side analysts who cover their stock and publish research and guidance to investors.

Guidance was typically top line and bottom line, revenue and earnings and the street would come up with a consensus on what EPS (earnings per share) the company would earn in the following quarters - often based on complex models developed in the wee small hours of the night by hard working young analysts.

Setting, and then making guidance worked well for high quality companies - they earned investor trust and were rewarded in the stock price - and the process could also create controversy when, for example Google said it would not provide guidance because the founders did not want to ever sacrifice the long term for a short term reporting need. If you're Google you could get away with that, but only the rarefied few could, and in the past most would have been crushed by such arrogance.

So what happens now? As reported by MarketWatch, an increasing number of companies like GE and AMD are stopping guidance in the current downturn because they have simply lost good enough visibility to be able to provide it with integrity.

It's an ethical and practical dilemma. If the CEO doesn't provide guidance he's not supporting his investors - one of his key constituencies - and their need to understand the company's expected performance in order to value to stock. If he does provide guidance and he really doesn't have enough visibility then he could be misleading his investors (and setting himself up for shareholder lawsuits).

I'm a big believer in transparency and over time that companies will be rewarded for it. Many institutional investors are investing for the long term - more so now than in the recent past - and want and need companies to share the metrics that drive their businesses in order to build their models and understanding. Transparency may not be EPS guidance, but it should be the best information the company can provide to share the outlook management sees. Companies withholding information or being coy about it infuriates investors, as well it should (and even worse is when they miss lead investors by manipulating revenue, as does still happen).

It takes courage for CEOs and CFOs to be transparent and help their shareholders really understand what's happening to their businesses, but I believe that in the long term - and following the downturn - the CEOs that figure out how to stay transparent will be rewarded.

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