Comp for Culture

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Shareholders are increasingly focused on measuring non-financial performance indicators of a company’s health. CBM recently spoke with Kathryn Neel, managing director of independent executive compensation firm Semler Brossy, about what this means for compensation committees in 2019 and beyond:

We’re seeing more shareholders get vocal about longer-term strategic measures of performance. They’re asking what boards are doing to incorporate that into their pay plans. How are your clients responding?

We’ve heard a lot about ESG in today’s environment, and shareholders are asking questions around non-financial drivers of companies’ success, or risk factors. The questions are turning to more forward-looking things, like how is your company managing for innovation in today’s environment? How are executives managing risk in the corporate culture? How are they planning for a different workforce, a labor shortage or a supply shortage in the future? Then the dialogue turns to, “Okay, if those are so significant to your business, do they belong in your incentive program? And do they play a role in how executives are rewarded?” Our clients are having these conversations with shareholders, and these topics are making their way into board and committee discussions.

How should boards approach measuring this? Because it’s not as clear a measurement as financial metrics.

That’s one of the main challenges. If you think about diversity and inclusion, for example, a lot of companies have shied away from including it in their incentive programs because they’re tentative about establishing a measurement or a metric and to whom they would apply. Not all non-financial metrics need to be measurable, but many are once a company has defined what it wants to achieve.

How are comp committees factoring in culture as one of these non-financial metrics?

It’s not an easy thing to embed in a compensation program. Where and how do you do it? Is it measurable, is it not? We already have clients who, for many years, have reviewed employee engagement surveys, for example. But a really great emerging practice by compensation and human resources committees is reviewing an HR scorecard that looks at all types of metrics—quantifiable aspects like employee retention, employee turnover, employee engagement—and other issues, such as sexual harassment claims and how they’re being managed and treated. It entails getting down into details in areas like gender pay equity, advancement on a gender or minority basis throughout the organization. So there are ways that a committee or a board can monitor indicators of corporate culture and the health of the corporate culture.

On the pay side, the only place I typically see it factored in is when, for example, a CEO is evaluating his or her direct reports and discussing how those direct reports are developing the next level of leadership of the organization. Are they contributing to talent development and talent retention or not? What’s the perception of their organization internally, their function or their division?

A board needs to encourage the management team or the CEO to consider those factors. That doesn’t necessarily mean as explicit adjustments to the bonus—but at least the executives should know that these things are being discussed and that the board takes them seriously and wants to know what impact the executives have on culture.

In the cases where you’re starting to see your compensation committees do this, what is the reception from CEOs? Are most CEOs open to these non-financial metrics?

There’s a mix. Some have already been presenting performance evaluations that touch on those aspects of performance. Others very much feel that they handle this outside of the committee and they’re on top of it. They want to reassure the board they’ve got it, but they’re a little less comfortable opening up the curtains and letting the board see what’s behind.

I think many companies will get there. The committees are getting there. There’s a need to go there. And the management teams will have to react accordingly.

What’s the most important takeaway for board members as they evaluate their compensation incentive programs and incorporate the non-financial metric side of it? What’s the action item?

Be prepared to talk to your shareholders about what drives success in your organization, and what types of measures you use to gauge your success in the strategy that you’re pursuing. Investors will be asking where they are—and if they’re not in the incentive programs, why they’re not there.

This interview with Kathryn Neel was originally published in the Corporate Board Member Q1 2019 issue. To see the published interview, download the PDF or read the online version.