Capital Steps

Capital Steps

I once had a colleague who was an acronym addict. His philosophy was anything more than a TLA (three letter acronym) was inefficient and confusing. If the name of a product or service required more than a TLA, he would insist it be changed to something shorter (not my strong suit). I have been doing a lot  of presentations on the Dodd Frank Wall Street Reform and Consumer Protection Act and the title alone nearly fills my twitter message box. For the sake of simplicity and my tweet stream, I am going to use the efficient DFA (Dodd Frank Act). By now, you have probably seen the list of items that compensation professionals must add to their to-do list. For those of you who have blissfully buried in high-priority, pressure cooker-type projects here’s a quick run down.

•    Votes on ‘Say on Pay’ (MSOP) •    Votes on ‘Golden Parachutes’ •    Compensation committee independence for public companies •    Compensation consultant independence •    Pay versus performance disclosure •    Ratio of CEO compensation to average employee •    Mandatory claw back provisions •    Formal employee anti-hedging policy •    Limited broker voting •    Enhanced shareholder proxy access •    Company disclosure of Chairman / CEO role •    And..MORE!

So, what does this all mean to the professional who already works significantly longer than a 45-hour workweek, even during the so-called “slow” months? First, it means you have to get started on a project plan that outlines how you will approach each of these items without materially impacting everything else you do. For larger companies, this may be limited to assigning specific topics to members of your compensation team.  For smaller companies, this most likely leads to categorizing items along with your normal activities. Second, it means there will be no shortage of work to go around.  And, lastly, it means that as a professional you must be nimble and know how to adapt quickly.  Get ready for a fun ride. The beauty of all of this is that it allows you to direct compensation evolution in a way you have envisioned for years, but did not have the support or budget to accomplish.

If I were a company, the following would be my top three priorities.

Priority 1. When looking at the DFA, ‘Say on Pay’ is the most obvious driver of compensation restructure. Most academic studies also support ‘Say on Pay’, touting it as the single biggest catalyst in the move to performance-based pay. This provision is pivotal as it dovetails with another DFA requirement to disclose the link between pay and corporate performance.

Your company’s first step should be to look into creating a ‘Say on Pay’ stakeholder team. This team’s objectives will be to review how investors have viewed your past pay practices and begin to define communication, plan structure and performance metrics to help reduce the chance of having a “no vote” at your 2011 proxy.  This team can also discuss whether the company’s approach will be to aggressively attack shareholder hot points and perhaps get corresponding positive press or to adopt a wait and see approach by acting only after peers have announced changes or shareholders have started pushing for details.

A recent study by F. Ferri finds that CEO pay in companies with excessive compensation practices dropped an average of 38% after the implementation of a ‘Say on Pay’ provision.  For these companies CEO compensation dropped an average of $7.3 Million during the studies time span of 1997-2007. It becomes immediately important to understand whether your company falls into the “excessive compensation” category and how that will impact your preparation for shareholder compensation votes.

There are also some less obvious immediate drivers of increased responsibility for compensation pros.

Priority 2. The compensation consultant independence provision is written broadly enough to allow firms to provide more than compensation consulting. While combined services are allowed, many compensation committees may adopt a more conservative approach to reduce the any appearance of conflict and the need for additional explanations.  There is also a looming question of who will be defined as a consultant or adviser for compensation issues. Will your company’s legal counsel or tax adviser be included in this disclosure? Will an outsourcing or software provider fall into this category?  It is too soon to know how the SEC will finalize this provision, but it is a good idea to evaluate to who you get information from and how that relationship might be impacted.

Priority 3. The CEO to Employee compensation ratio requires that the compensation for all employees be determined using the “Summary Compensation Table” methodology.  There are very few companies that currently have this capability. Furthermore, it could very well require significant administrative costs and effort to accomplish this. There is the added complication of clearly reporting on average employee pay when you may have a workforce structure that deviates from that of your peers.  If your company currently has significant amount of work performed by employees in low cost locations, your ratio may be artificially high due to the low wages you pay. Conversely, if you have fully outsourced much of your administrative or manufacturing work to non-employees, the ratio may be relatively low due to having fewer employees at lower wage rates. Preparing for this issue will require a combination of new strategic and tactical skills, as well as some new tools.

These three provisions are just a quick start for all of us. Many of the details of the DFA have yet to be determined and communicated. These three priority items simply give us something new to work on while we wait for final answers on several other issues.

If you disagree with my big three please list yours in a comment and explain why they made your list. At this point in the game, all points of view are valid.  If we can get the discussion started now, we may be able to accomplish the intent of this legislation and simultaneously transform compensation at the same time.

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