- On July 23, 2017
Over the course of our Executive Compensation Consulting careers, we have been through several dozen finalist meetings with Compensation Committees. Most went fine. Some didn’t. Almost none were memorable. Most Compensation Committees asked the same questions of the firms they interviewed, few of which served to provide any insight into how each consultant would advise the Committee differently than their competitors. Many questions focused on how much experience they had in the industry and how the market data is collected — questions that lead toward pay levels and pay practices that would look exactly like their peers, not questions that provide insight into how pay practices would support their company’s unique business strategy. Some of the more insightful questions delved into unique perspectives on executive pay, and the ability to step away from market data – how to pay differently.
These are a few of the more thoughtful questions we have been asked during consultant selection interviews, with a few others we wish we had been allowed to answer. We offer some additional thoughts into why each question would provide insight for the Committee and add value to the process of selecting a great executive compensation consultant.
Personal philosophies on executive compensation
What does “pay for performance” mean to you? How will you ensure we pay for performance?
Pay for performance is ubiquitous. Every company espouses it. But many companies don’t know exactly how to articulate what it means, either internally to employees or more importantly to external audiences like shareholders. Your consultant ought to be able to articulate how he or she thinks about pay relative to performance: how performance should be defined; how pay levels ought to relate to performance levels; and present you with a framework to help think through the various dimensions of pay and performance.
We believe that an effective pay for performance philosophy must address all three dimensions of the relationship: (1) Pay for the right performance [i.e., selecting the right measures for your incentive programs], (2) Pay for the right amount of performance [i.e., setting appropriate performance goals], and (3) Delivering the right amount of pay for the right amount of performance [i.e., appropriately calibrating your incentive plan payouts].
Do you have a particular point of view on long-term incentives? How valuable are stock options or time-vested restricted stock?
The most insightful consultants with whom we’ve worked have evolved their thinking and developed their perspectives on what incentive programs work best. Not only can they communicate trends and prevalence of various LTI approaches, but they bring a point of view as well.
What is your personal perspective on simple incentive programs vs. sophisticated incentive approaches?
There is a time for sophisticated incentive approaches, and every consultant will be eager to share the three or four programs they are exceptionally proud of designing. However, effective consultants ought also be able to articulate the value of simply-designed programs, and which times and situations are appropriate for a simple approach or a sophisticated approach.
What should be the implications of a company which fails its Say on Pay (SoP) vote? Should the Compensation Committee terminate the relationship with their Advisor? Should the Committee Chair or members remove themselves from the Committee?
While the instances of companies failing their Say on Pay vote are rare (only about 1.5% of companies failed SoP in 2017), few companies have discussed what would or should happen if they fail SoP, or if the company fails to achieve 70% approval (generally considered the minimum for a “good pass”). We believe that while the Compensation Committee ultimately has responsibility for pay decisions, it is the consultant’s responsibility to advise and persuade the Committee to avoid actions that are not shareholder-friendly or will otherwise risk “No” votes from shareholders. At a minimum, Committees ought to consider switching their executive compensation consultant after a failed SoP vote.
Where should Compensation Committees devote their time?
Most Compensation Committees do a solid job of setting executive compensation levels, incentive opportunities, and determining payouts at the end of the year. However, over our careers we have worked with numerous Committees that fall short in other areas of executive compensation and related governance issues. We believe that most companies would benefit tremendously if Compensation Committees devoted more time to (1) discussing performance measures and goals for their executive incentive plans relative to their business strategy and organizational priorities, and on (2) executive succession planning to ensure future leadership can be sourced from within the organization rather than hired externally. Both of these issues are of extreme importance to shareholders and often receive less Committee attention than they deserve.
How important is industry experience for our industry? How can you ensure that our pay programs will not look like every other company in our industry?
This is the question that is asked the most, but that probably has the least relevance to selecting the most appropriate consultant. Few industries require “industry experience” — we would probably argue that industry experience is valuable in industries that have a materially different approach to pay (e.g., equity pay practices in technology industry), and a handful of industries that are regulated (healthcare, banking) since the universe of potential business strategies is limited by regulators. For companies in other industries, it is probably more useful to hire a consultant that has experience with your unique business issues, not necessarily industry issues.
Ability to provide independent and customized advice
Have you advised a client to target overall pay below market?
It is easy to pay more (budget/cost considerations notwithstanding), but it is significantly more difficult to manage pay to targets below market-competitive levels. Doing so has risk for recruiting and retaining talent, but allows for more flexibility with other investments in the overall business. In fact, there are several situations in which companies should accurately target pay below the competitive market: when employee benefits are more generous (therefore more costly) than the competitive market, or when performance expectations are below market-competitive levels, or when the talent required by your business model (perhaps a low-cost product offering with automated manufacturing processes) does not need to be world-class.
Give us an example of when you advised a client to target pay ABOVE the 50th percentile, or AT/ABOVE the 75th percentile?
Examples for targeting pay above the 50th or 75th percentile should be easy to identify. For example, when performance expectations (demonstrated by data and analysis, not by anecdote) are above the median or 75th percentile of peers, or when benefits lag competitive market levels.
What is the most unconventional pay program or compensation strategy you have developed for a client, or that you are aware of in other companies?
This question should allow your consultant to show off their creativity and innovation. Examples might include sophisticated incentive programs, or programs that attempt to address external influences on performance results, or innovative or sophisticated financial performance measurement programs that are incorporated into incentives.
Tell us about an example of when you have advised a client to do the opposite of a best pay practice.
Most Compensation Committees benefit from a true “advisor”, not a “prevalence consultant”. External data on compensation levels and trends is easy to find and compile (and free!), so you shouldn’t be spending a fortune on the competitive market data. The real value of a consultant is in (a) interpreting the data and communicating its relevance and (b) recommending compensation approaches and decisions that are appropriate for your company — regardless of what prevailing practice or emerging best practices are. Your consultant ought to be able to demonstrate numerous examples of when their advice deviated from prevalent market practices.
Have your recommendations ever been rejected by a compensation committee? What was the situation and what were the considerations?
Experienced consultants have amassed dozens of instances in which they have recommended one course of action, and the Committee decided on the alternative. These examples will provide you a sense for how strongly your consultant believes in their recommendations (or if the recommendations will be a more wishy-washy “you could do A or B or something in between”), how willing they are to try to convince you of their point of view, and under what circumstances they would be willing to defer to an alternative point of view.
If management wanted to increase the payouts of the annual incentive program, how would you evaluate their recommendation to provide independent guidance to the Committee?
An effective consultant should be able to explain how payouts ought to align with the degree of difficulty of performance goals (i.e., a 75th percentile payout may be entirely appropriate if a superior performance goal reflects performance at the 75th percentile of industry peers), and more importantly, how they would approach testing the degree of difficulty of those goals with empirical financial performance data, as well as future performance expectations of investors, analysts and stock price implications.
Consulting approach and logistics
Why is an independent consultant preferable to our Company’s CEO/HR/Legal professionals in providing data to the Compensation Committee on executive compensation matters. What do you think is an appropriate balance of internal HR time and outside consulting fees for our Company?
There are a wide variety of client consulting relationship models that can work effectively. We have worked with Committees in certain situations where zero HR/Legal resources are used — where we complete 100% of supporting analyses and develop 100% of the recommendations independently of management. We likewise have worked with Committees in which HR completes 100% of the analyses (with our review and oversight) and we develop recommendations in conjunction with the HR/Compensation team. Most Committee relationships operate somewhere in between these two extremes.
For many companies, the value an outside consultant provides is less in the data and analysis (which frankly can be gathered and analyzed by internal company resources), but more in the experience with companies facing similar business circumstances and strategies. The appropriate balance of internal HR resources and external consulting time and fees should be a function of how company resources (HR time or company money) can be optimally deployed.
How will you avoid perceived conflicts of interest? What happens if management asks you to evaluate a compensation package for a new executive or provide advice on incentive design?
For firms focused exclusively on executive compensation, few conflicts should arise. Companies considering using an executive compensation consultant from a diversified HR consulting firm should consider the potential for a perceived conflict of interest relative to the value offered by the consulting team. Once you retain a consultant, work with them to establish guidelines for how they will work with management on any issue prior to beginning work. This should eliminate any surprises for your consultant, management or the Committee.
How should the Committee evaluate the performance of their consultant? Do you believe in “term limits” for consultants?
Every Board should be conducting Board and Committee evaluations annually. In conjunction with these annual reviews, Committees should be completing annual reviews of their consultants to evaluate timeliness of delivery, quality of work, independence of advice, alignment of recommendations with company strategy and circumstances, and yes, fees. Bottom line, is the Committee getting effective value for the resources the company invested. As part of the annual review, the Committee should solicit input from the HR team working with the consultant firm.
“Term limits” for consultants are unusual, but many companies prefer to bid their consultant relationship every 3-4 years (or whenever a key member of the consulting team resigns), both to understand whether fees for their typical scope of services are reasonable relative to other firms, and also to understand different perspectives and points of view. Even if the same consulting firm is retained, a “second opinion” on peers, pay levels, and incentive approaches might be sought every few years from a different firm.
How frequently does a member of your team disagree with your recommendations? How can we ensure that we receive dissenting opinions if someone from your team does not agree with your personal recommendation?
In our experience, consultant recommendations are frequently driven by the project manager on the relationship, at least as much as the most senior consultant to the Committee. In certain situations, different members of the consulting team may have different perspectives on the best approach for the company. These questions will help you understand if and how much your senior consultant will be willing to bring to the Committee the alternative perspectives of the team.
Knowledge of your business
What do you know about our business? What do you believe are our most important strategic priorities?
Every consultant will be able to repeat the standard size, industry, business approach (we hope!). Some will be able to derive insights into your business strategy and organizational priorities, and the best consultants will be able to turn those insights into implications for continuing or changing certain executive pay practices for your company.
How would you characterize our company’s recent performance?
This is not a common question, but it should differentiate those who have done their homework and those who have not. It will also help to understand whether the consultants view performance through the lens of the organizations’ business strategy, and/or relative to competitors, and/or relative to shareholder results. Depending on your company’s performance, this question may help to differentiate those consultants who will be willing to share the “hard truths” with the Committee, and those who will be reluctant.
With whom do you think we compete for executive talent? For customers? For capital? How do you think we are different from our “peer group”?
Comparator groups — for pay benchmarking and for performance benchmarking — is becoming a more and more important issue for executive compensation and is under increasing scrutiny from external audiences (in some instances, for good reason). Your consultant should be able to articulate what characteristics of your business make you similar to or different from your “peers”.
What is the “reddest flag” or “yellowest flag” in our disclosed pay practices?
Consultants are adept at scanning a proxy statement for poor pay practices: tax gross-ups, non-performance-based pay, excessive benefits or perquisites, high CEO pay levels, generous equity vesting provisions, and so on. Most consultants will be able to offer at least one or two areas in which pay practices could be improved, even if it isn’t technically a red or yellow flag.
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Regardless of whether you use these questions or not during you next executive compensation consultant selection process, we would encourage all Compensation Committees to discuss issues that provide insight into how each consultant reconciles internal business priorities with external market practices and how each factors into their recommendations for pay levels and design. Your company’s executive compensation programs should be designed to support your business strategy and organizational priorities, not to mirror your competitors’ programs, so your Committee’s advisor should be a strategic business advisor, not just a prevalence consultant. Best of luck!
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Sheffield Barry is an Executive Compensation and HR Consulting firm, providing customized advice to clients at an affordable price. We leverage technology to deliver data and analysis as efficiently as possible, so we can invest more time understanding our clients’ unique business issues to develop custom solutions and advice. For more information, please visit us at SheffieldBarry.com or email us at info@SheffieldBarry.com.