In a recent episode, Matt Isakson, partner with Meridian Compensation Partners, offered several best practices for making these high-pressure processes flow more smoothly for compensation committees. In this blog, we take a deeper dive into the committee’s goal-setting responsibilities.
The Ultimate Balancing Act
“How far can we push the company forward, while still ensuring that the compensation goals are achievable?” This is a delicate balance that each committee must strike. A company’s compensation goals can be a powerful motivator for internal growth and talent development, as well as a point of great scrutiny for investors and proxy advisors. Furthermore, it’s nearly impossible for boards to know how unpredicted events of the coming year may impact business operations or revenue projections.
Isakson notes some interesting trends regarding today’s goal-setting process:
We’re seeing compensation committees really feeling empowered to start asking these questions on goals. Contrast that with management teams that perhaps aren’t as accustomed to the compensation committee asking them questions.
Given these dynamics, Isakson recommends that committees use a two-meeting approach when it comes to goal-setting. The first meeting (in January) allows management an opportunity to give their initial recommendations on the goals; this preliminary meeting gives committee members the chance to ask questions, request additional data, and raise any initial red flags to management. The second meeting, as a result, can be very decisive. This two-meeting approach is still a minority practice, said Isakson, but it’s one that’s been very effective for Meridian clients.
Four Guiding Perspectives
To ensure that compensation committees are being comprehensive in their goals assessment, Isakson outlines four guiding perspectives or data points that all committees should consider.
1. The Company’s Historical Performance
As boards look into the future, it’s important to also look backwards. Past performance is perhaps the most logical starting point: How has the company performed against goals in the past? Are they consistently exceeding maximum? Are they not hitting threshold at zero payout? Ultimately, what’s the story?
2. Historical Performance of the Company’s Peer Group
The compensation committee must consider how the company has been setting goals relative to its peer group, says Isakson: Is the committee setting its targets at the 25th percentile of the peer group’s historical performance? If so, what is that really saying about the committee’s rigor and goal process on a go-forward basis?
3. Investor Expectations
While historical performance is a good benchmark to consider, committees should also be looking forward. Investor expectations are a critical factor in the goal-setting process. Not only should committees be looking at their guidance, but also the analysts’ consensus, says Isakson: “If you’re coming in at a target EPS of $2.00 and the street’s expecting $2.50, that can be an issue when the proxy roles out the next year—that you paid target or even max for an EPS goal that was below the consensus estimate.”
4. Sharing or Cost Ratio
Sharing or cost ratios can often be difficult market data for companies to gather. Essentially, the question is: Are we sharing enough with employees vs. shareholders—especially at that maximum level? As a percent of maximum performance, committees must consider how much is going to shareholders and how much is coming back to employees.