With the constant clamor by shareholders for better governance, compensation committees have become ever more transparent about handling executive pay but there's a missed opportunity.
The transparency can also give shareholders confidence in the overall governance of the company by the board.
Good pay program design and execution, simply put, is a surrogate for good governance. Give shareholders confidence in one, and they will have reason to believe they should have confidence in the rest.
Why give them any doubt that directors are keeping on top of the governance game?
Here are four best practices for boards to capitalize on the clarity:
* Competent Communication. Hold regular, scheduled meetings with key shareholders. The compensation committee chair or lead director should go with the corporate secretary (or general counsel or HR chief). Don't wait for complaints at the annual meeting. Give shareholders, including their governance experts, a chance to offer face-to-face, unfiltered feedback. This allows you to show your command of a range of governance issues.
Following in-person meetings, show you value feedback by making changes in the pay program, or looping back to explain why you didn't. When you meet with shareholders, you do run a risk that they won't like what they hear. One investor we encountered had less confidence in a company after meeting with directors, because the directors didn't have command of all the issues related to pay. So do your homework and let shareholders see your meticulousness.
* Balancing the Up and Downsides. Show that performance and pay align with good times and bad, over the long term. Shareholders obviously detest a plan that pays no matter the performance, so goals should be set not just to trigger generous bonus payouts in up years but to curb them in down years.
It goes without saying that you can't overly dock executives for a run of bad industry luck, lest they lose their commitment to hanging tough and gain a yearning for greener pastures. But be sure your pay program "auto-corrects" on the downside, shrinking peak payouts during valleys of performance. For example, during a bad year, a payout of, say, 70% to 80% of target sends the right message to executives and shareholders. Everybody shares the pain.
In the meantime, explain clearly your rationale when you use discretion to adjust pay on either the up or downside in a way that deviates from the pay plan. Be wary of making exceptions just...