Why Human Resources Executives Can Be The Stewards Of Compensation

December 2, 2014 | Forbes

A Q&A with DHR International and Farient Advisors

By Robin Ferracone

On November 4, 2014, Jerry McGrath, DHR International’s Global Human Resources Practices Leader, invited me to join him at the Harvard Club in New York City for a Chief Human Resources Officers (CHRO) executive breakfast. With more than 30 HR executives in attendance, we thought it would be fun to create a program with dynamic audience engagement in the style of the well regarded television program “Actors Studio.” As an executive compensation consultant for more than 30 years, I have found that the expediency and overall success of our work depends on great collaborations with the HR community. That’s why I want to share an excerpt from our breakfast conversation.

Jerry McGrath (Jerry): Robin, broadly speaking, what is happening in executive compensation right now? What would you say are the biggest challenges?

Robin: There is always a prurient interest in executive compensation that never seems to leave the headlines. We are all in the middle of that and of course we want to avoid being in the headlines, which always makes our work interesting.

At the moment, the focus in executive compensation is on the CEO Median Pay Ratio disclosure, also known as Provision 953b of the Dodd Frank Act. This pending disclosure will require public companies to report the CEO to median worker pay ratio. The big question right now is, “Is that going to mean much?” Since there are numerous ways companies can disclose the CEO pay to median employee pay, there is no way to compare the ratio across companies, making it of questionable value.

Jerry: How are you advising your clients on this topic?

Robin: My advice on this is to look at the preliminary calculations, see how you’d interpret the numbers for shareholders, and then leave it at that. One of the things for human resource executives to consider is how to disclose and communicate the findings, and to what extent can you keep it low key?

Jerry: How do you work with HR directly?

I am glad to have our HR colleagues in the room. From our point of view, we believe that everyone is best off when we all collaborate with management. Good ideas can come from anyplace. At the end of the day, we are all working for the shareholders.

As such, we believe the role of HR is very important, and we like working closely with the HR team as well as the compensation committee of the board. If we don’t work closely together, surprises inevitably arise, and no one likes surprises – at least in this context.

I spoke a few years ago at the World at Work International Conference on the roles HR should play, and about what roles HR should not play in the compensation planning process. I have to admit, it was easier to come up with the roles HR should avoid. These include:

  • CEO advocate: This approach does not play well with the compensation committee and sets up an issue of trust
  • Peacekeeper: Some eggs may need to be broken to make an omelet
  • Copycat or scared-y cat: HR shouldn’t be afraid to proffer opinions. HR deserves to have its own point of view heard

In short, HR needs to work with management and the compensation committee to ensure that executive interests are aligned with shareholder interests.

Jerry: You have terrific marquee clients. To what degree do you work with companies that aren’t doing well, for example, companies that have reputation issues, market erosion and/or stock price declines? How do you design, consult, and advise on compensation packages for these types of troubled companies?

Robin: Our clients come from all walks, so to speak. We have high performers, low performers, large mature companies, entrepreneurial companies and private companies. Name a genre, and we have worked there.

Low performing companies present a unique challenge. Let’s go back to the whole pay for performance question because when we think about retention, there is nothing better for retention than a high performing company. If you are a low performing company, you may have good people, but they are the hardest to retain and you don’t have the holding power. That is the real challenge. We’ve been through these vicissitudes with clients. What we try to do is walk the fine line. Let me give you an example. We had one client with a very low, depressed stock price: too much debt, compounded by the fact that the private equity owners had put the debt on the balance sheet in the first place. At the time, the stock price was super low and that created a dilution problem, since we were trying to give executives competitive awards in equity. The question became, how much dilution could the company withstand, and at what point were we going to cross the line over to a low say on pay vote? Meanwhile, the private equity investors were up in arms because they didn’t want to give away more equity than necessary.

The other piece, though, was compensation within the organization. Compensation is a resource and you need to think of your dollars and equity value as a scarce resource. You can’t succumb to the Lake Wobegon Effect (a natural tendency to overestimate one’s capabilities in a world where everyone is above average). In this case we had to design a principles-based format to determine when it was okay for someone to be above market and when others needed to be at or below market. We had a key principle that if we had a really critical talent we could not afford to lose, we would pay them between the 50th and 75th percentile, but needed to tilt toward cash since the equity wasn’t doing its job from a compensation perspective.

Robin: Jerry, let’s turn the tables here so to speak. I have a question for you. If you are recruiting for a low performing company, how do you go about it?

Jerry: We only get the hard searches. Seriously, if it were that easy, our fees might scare people away (ha). The issue with a low performing company is that we need to work extra hard and it comes down to the rapport with the CHRO and trust that person has for getting out of the “ditch.” We really look at a wide variety of candidates. There are people who always say, “I don’t want to be at a well-oiled machine. I want to demonstrate that I can really turn something around.” When we look for candidates, we ask them to see through the noise in terms of what the buzz is around a poor performing company. I always like to point out that there are only 1000 companies in the Fortune 1000 and only 1000 CHROs. Those jobs are hard to get and there is only a 15 percent attrition rate at the Fortune 1000 level. Those jobs are like US senate seats or governorships. Only 150 per year become available.

Robin: Where is compensation in your search process?

Jerry: Compensation is our mantra. It has to be internally equitable. The HR officer coming in has to open the books and see how everyone is paid and they have to see that they have all of the same risk propositions and all of the same cash components somewhere in the middle. It’s just internal fairness. There should be no “hide the ball,” no, “whoops, did we forget to tell you this?” Our advice to the CEO and/or the board of directors during a search is, “Let’s make it a fair offer and make sure that the offer has all of the incentives in place.”

Jerry: How is Farient working with clients to link talent to compensation?

Robin: Linking talent and succession planning to compensation is an emerging topic. What’s been interesting at the top of the house is how talent and compensation have been two vertical exercises, often siloed. I think there is more attention today on bringing them together. If you think about pay for performance, most organizations want to think about pay in terms of “what have you done for me lately,” rather than looking at potential. I‘d say compensation has largely been a backward-looking exercise. But, more companies are asking, “Where are we going to be down the road?” and “What is this franchise we have to protect?” Linking talent and compensation is becoming a topic of conversation, but it’s still not mainstream.

The other interesting thing is succession planning. How many of you have gone through a succession planning cycle for the CEO or other high level executives? It’s tricky. You want to make sure you aren’t just setting the compensation for the successor coming in, but also looking at compensation for those who are internal candidates. You want to look at the extent to which you pay internal candidates to stay in the chair while the search process is taking place. We went through a rather public process with one of our clients where we helped them link the talent/succession and compensation processes together. At that point, there were some internal candidates and some external candidates, and we wanted to establish retention awards to make sure the internal candidates stayed in place. So the vesting of RSUs was timed for beyond when the new CEO would come in. They also took the outgoing CEO and linked some of his compensation to how well the succession process went, and delivered that compensation in the form of equity that would vest after the succession process had taken place.

Jerry: Robin, thanks so much for joining us today. As we wrap it up, give us the main takeaways HR people should be thinking about right now.

Robin: Thanks Jerry. I’ve enjoyed this. To wrap it up, here are the five areas HR can focus on to become the stewards of compensation:

1. Regulation: When it comes to the CEO Median Pay Ratio disclosure, keep it simple. Interpret and clearly communicate the numbers for shareholders. Keep it low-key.

2. Shareholder Engagement: Engage with shareholders and proxy advisors, but at the right time. Listen carefully to their thinking, ideas and concerns, but don’t feel you’re wedded to them in your design. Instead, wed yourself to your company’s strategy

3. Linking Talent to Strategy: Compensation has largely been a backward-looking exercise. We need to look forward in order to protect our talent franchise. As you think about retention and workforce planning, you need to think about how to link talent planning to compensation

4. Managing Dilution and Talent Retention: For a struggling company, you must recognize when equity isn’t doing its job. You need to think differently about how to compensate in this environment.

5. Build Trust and Collaborate: The best approach is to work collaboratively with both compensation committees and consultants. Be engaged in the process and refrain from advocating for the CEO.

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