Demystifying Executive Compensation Design for Public Companies
August 3, 2023
Shelly Carlin unveils the secrets behind determining executive pay, navigates the scrutiny from media and policymakers, and explores the emerging trends shaping this landscape. Join us as we unravel the challenges faced by companies, delve into the evolving ties between executive pay and ESG factors, and ponder the controversial notion of linking CEO compensation to their employees.
Executive Vice President for the HR Policy Association and former CHRO at Motorola Solutions.
Felicia Shakiba 00:04
Hello, everyone. I'm Felicia Shakiba. And you're listening to the CPO PLAYBOOK podcast. Join me and my guests as we feature insightful conversations with HR leaders, people scientists, and executives from diverse industries and functions, offering valuable perspectives on the future of work. Discover a unique outlook on navigating the complexities of the modern day working world. Exploring innovative strategies and Talent Management and corporate culture from the Chief People Officers perspective, tune in to stay ahead of the game when it comes to all things people related.
Felicia Shakiba 00:44
Executive compensation in public companies has long been a subject of fascination and bewilderment. Shrouded in an air of mystery that leaves many people questioning its intricacies. With growing concerns about income inequality and calls for greater transparency, the topic has gained significant attention in recent years. The complexity of executive compensation design with its multitude of factors, variables and performance metrics, adds to the challenge of understanding how these packages are structured. Furthermore, the confidential nature of compensation agreements and the influence of compensation committees can make it difficult for the public to grasp the rationale behind executive pay decisions. In order to shed light on this enigmatic realm. We are privileged to have Shelly Carlin, an esteemed expert in the field of compensation and corporate governance joining us today. With her extensive knowledge and experience, she will help demystify the intricate world of executive pay design. Shelly, thank you so much for being here. Welcome.
Shelly Carlin 01:56
Oh, it's great to be here. Thank you for having me.
Felicia Shakiba 01:59
It's our pleasure, Shelley, your current role is that the HR Policy Association, what exactly does that association do?
Shelly Carlin 02:08
Yeah, HR Policy is a public policy organization based in Washington. And basically what that means is, we work to influence public policy at the federal level, with respect to anything having to do with human resources. So our main clients are members of our association, are Chief HR Officers. They're Chief HR Officers of about 400 of the largest companies that do business in the US and globally. And so we really are trying to make sure that the public policymaking process and the regulatory process reflects the input of the HR professional in the CHRO's, specifically.
Felicia Shakiba 02:45
And can you explain to our listeners, what executive compensation is, and how it's determined?
Shelly Carlin 02:54
Yeah, executive compensation is used to refer to the pay programs that cover an organization's CEO, and its most senior leaders. These are the executives that are typically disclosed in the company's public filings, their pay is disclosed by regulation. And so that's really what people kind of mean when they say executive comp. The program's also applied to executives below that top level, but it's a pretty select group that we're talking about when we talk about executive pay. And it's basically like other elements of compensation, there's base salary, there's annual cash bonuses, and in case that differentiates executive compensation really is the third component, which is long term compensation, which is essentially delivered for the most part in the form of stock or stock based kind of compensation.
Felicia Shakiba 03:45
And how do Chief People Officers- how do they contribute to aligning the interests of executives with those of shareholders?
Shelly Carlin 03:54
So the CHRO is really important in this process. And I actually before I became a CHRO, I came up through the executive compensation function and the total rewards function. And the key role that the CHRO plays is really as the main representative of management to the board, and specifically the compensation committee of the board, who has jurisdiction over pay programs. So the CHRO, makes sure that the interests are aligned by running the process. So I look at the CHRO as the orchestrator of the process. So when you think about it, it kind of goes back to how the decisions get made, and that really defines the role of the CHRO. The decisions are really the purview of the board, and as I said, the Comp Committee. And what makes it different, though, than other decisions around comp and how those interests get aligned is that there are a lot of important stakeholders in the world of executive comp, and some have more ability to influence the outcome than others. The CHRO really plays a role in guiding a process that makes sure that all those stakeholder interests are accounted for based on the board's preferences and the board's desires, but the CHRO is really at the center of all of that.
Felicia Shakiba 05:02
In your opinion, what are the key challenges? And I know that you kind of mentioned that there are many, many stakeholders, what would be the greatest challenge facing companies when it comes to setting executive compensation?
Shelly Carlin 05:15
Yeah, I think the major challenge is balancing the interest of those stakeholders, and we talk about them in basically six different kinds of stakeholders. Number one is investors and investors still and always are kind of the primary stakeholder when you talk about executive banks. But there's also others one that's not really well known by most people, particularly outside the the tiny little world of exec comp, or something called proxy advisors. And proxy advisors are intermediaries, they're out there, what they do is large investors who don't have time to analyze and determine how they're going to vote on thousands and thousands of shareholder proposals, they outsource a lot of that voting function determining how to vote, to firms called proxy advisors. And so over the years, these proxy advisors have gained a lot of influence in the area of executive comp, they have their own views on executive comp, they have their own views on what good executive comp is, and what's not. And they have really influenced investors in terms of how investors vote on pay proposals, which are part of the process of exec comp. So these proxy advisors kind of sit between investors and companies, and they really perform a very interesting function.
Shelly Carlin 06:33
The government is clearly a stakeholder as well. So the government by virtue of its regulatory power through the Securities and Exchange Commission is a key stakeholder. Media, particularly in the in the age of social media. A company's reputation, can clearly be at issue, if there's concerns or public outcry over their executive pay even customers, we've seen a lot of surveys that talk about how customers care about good governance and executive pay is considered a governance issue. And then finally, an organization's own employees, you know, how do you think about particularly in the post COVID world and the rise of employee voice and feelings of kind of making sure things are internally equitable? How do you think about what interests of all these six different stakeholders- who's primary and how do you balance all those so I do see, that's the number one challenge in executive pump is balancing the interests of those stakeholders. And I'll tell you that over my career in doing exec comp, the powers shifted, so there are a lot more of those stakeholders, as I mentioned, proxy advisors, media, social media, customers who have more power than they have in the past, and they're actually trying to influence the outcome.
Felicia Shakiba 07:45
That's interesting that proxy advisors could really hold so much weight on behalf of investors and ultimately, the future of executive pay. So how do you respond to criticism that executive pay is often too high and doesn't align with company performance?
Shelly Carlin 08:06
You know, I think that the question of whether it's too high, if you look at the data, all the studies basically (talking about the performance link,) the studies really show a very close correlation between the movement of pay, and performance. And the reason for that is the majority of pay, as I alluded to earlier, is delivered in the form of stock. And so as stock prices move, the value of that compensation goes up or down. So there's a lot of data that talks about that about how pay and performance are more aligned than they ever have been in the past. The more interesting question really is the first question you asked, which is, how do I respond to somebody who says is pay too high? And I think it depends on which stakeholder is asking that question. If it's an investor, who is saying, pay is too high, that's going to carry more weight with the company than if any of the other stakeholders say that because we still live in a investor primary model of capitalism in this country, and companies, you're gonna listen to that. So if an investor says pay is too high, they're typically saying, pay is too high relative to the performance that you're delivering for me. Most investors don't really have a problem with management making a lot of money if the returns to the shareholder are good. They're more concerned with the alignment of pay, not the level or what we call the quantum of pay.
Shelly Carlin 09:27
If other stakeholders however, particularly the media or government or employees, and the representatives, possibly labor unions say pay is too high, that's a really different kind of conversation, because they're basically saying, absent the performance link, there's just some arbitrary level of pay that is just too high on the basis of other values other than making a return for the owners of the business. And oftentimes those values are equity internally with other employees. Should one person make some much more than another? It may be in regard to, should CEOs make a lot of money when they're laying off workers. But those, again, are based on a different stakeholder view of the world that basically says, I'm not really as concerned with the alignment of performance, there's just an absolute level beyond which is too much. So it really depends on which stakeholder is asking the question. And offering the criticism is how you pay kind of look at that. And we are in a, in a changing world, not just with regard to executive comp, but we see it in other areas, which is, who truly are corporations beholden to? Are they truly only beholden to their investors? Or do they have a larger obligation to society generally. And so executive comp is really kind of you see symptoms of that debate playing out in the executive comp world as well.
Felicia Shakiba 10:52
That's interesting that you talk about that, because essentially, leaders could be criticized for always looking up instead of other employees and how they take care of them. And so with that being said, I'm just curious...so non financial performance measures have been incorporated into pay plans, but they have received both support and opposition. What are your thoughts on incorporating non financial performance measures? And how can companies strike the right balance in their pay programs? And that's something like employee engagement?
Shelly Carlin 11:24
That's a really great question because we've seen in my 30, plus years of doing this kind of work, the speed with which companies have moved to incorporate what's commonly called ESG, type metrics, or environmental, social and governance metrics, into pay plans, has been just really way faster than other changes that I can recall. So companies have really moved quickly, and I think that's a function of a couple of things. One, everybody's doing it. One of the things that goes on in the exec comp world is boards and comp committees really have an eye to what their competitors are doing. And so when one person does it, it's kind of self fulfilling that others do it depending on what survey you look at the majority of companies incorporating some sort of non financial metric into their executive pay packet. But we're seeing opposition to that from both proponents and opponents of these kinds of measures. And let me tell you what I mean. So there's opposition to including this from people who say, the only important stakeholder, the sole stakeholder, should be the investor and all companies should be doing is worrying about delivering returns to their owners, they should not be rewarding themselves financially for pursuing other goals that are not financial in nature, it's kind of the purest form of the investors, the primary and only stakeholder.
Shelly Carlin 12:42
There are people on the other side who might actually support these things like environmental goals, who are also criticizing companies by saying the goals that you're putting in, we don't have any faith that they are rigorous, that they are meaningful, that they're doing anything at all, to improve your environmental performance. In fact, we think you're putting them in there just so you can guarantee a payout. So there is this really interesting dilemma that companies are in about, what do I do when I look at non financial metrics? Kind of, the way that I look at this is any metric that you put in your incentive plan for executives, or anybody else needs to have some relationship, quantifiable relationship to your long term objective, and for most public companies in this country, that long term objective is delivering returns to shareholders. So if you can prove over time that something like you know, employee engagement scores, drives higher retention, lower turnover, which drives growing revenue, which drives better share performance, then there clearly is a rationale for that. But to say that we should put something in because it's the right thing to do really kind of is a little bit problematic, absent any kind of logical thought train, if you will, about how that's going to drive the business performance because, again, under current corporate law, and under kind of current practice, the investor is still primary.
Felicia Shakiba 14:17
There's a lot to unpack there. But I want to think a lot about what are the environmental, social governance ESG factors that you are seeing pull weight to implement into executive compensation that also increases the performance of the organization financially and so forth?
Shelly Carlin 14:41
I think the answer to that is we we don't have the data yet to say that. So it's still very like I said, this has happened really fast. Companies are struggling with what they can measure, and whether or not we just don't have the data whether there's any correlation between those things and longer term outcomes. What I will say is the most common things that we are seeing are in the "S" part of ESG, the social and that would include diversity, equity, inclusion representation metrics. So the majority of conversations that we are seeing, or the majority of interest in the ESG, for most companies has to do with the representation and diversity. Now, there are many studies that talk about how diverse teams do better and perform better than their are other studies that don't show a correlation. So again, there's a lack of solid, hard indisputable data- on like the financial side of the house where we've got decades of financial metrics, highly quantifiable, very consistent, very standardized, where you can basically say, for any given industry, yes, it's cashflow that's correlated to long term value, you can't really say that in the ESG world, which is why it makes it so difficult. The other thing to know about this while everybody's doing it, the amount of pay that's actually tied to these metrics, is pretty small. For the most part, people are putting these metrics in their annual incentive plan, which for an executive, maybe 30% of their total pay, if that. And so they're putting a metric in something that's 30% of their total pay. And that metric itself is only driving 10% of that bonus payment. So if you do the math, the actual impact of the executive's pay is minuscule. But the publicity the reasons that companies are doing this is more to demonstrate commitment to send a message about how important these issues are, with in terms of the scheme of things in terms of the actual amount of pay that's impacted by these metrics is actually quite small.
Felicia Shakiba 16:36
That's wild, because I feel like that might explain why a lot of companies are for example, hiring a Chief Diversity Officer, but don't really bring them into the room and sit at the table. Is that fair to say?
Shelly Carlin 16:54
I think that's all part of the same dynamic, it's all part of the same question of how do we solve the equity issue in corporate America? Is it going to be solved by putting a metric in the incentive plan? No. For the same reasons, it's not going to be solved by hiring a person to run a program, if that truly isn't part of the change in the culture that you need to see, to drive increased representation? How do you drive increased representation? Well, first of all, you have to attract, but then you have to keep and retain people who are different and elevate them in the organization. It's a symptom of the same underlying problem, which we haven't figured out as a society, let alone, you know, figure it out as a corporation.
Shelly Carlin 17:35
What is so interesting about this is the rapidity with which it's happened in terms of putting metrics and incentive plans are not the focus that people have had on it. And then when you actually look at how much of the pay that is been impacted, it's very small. There's been a recent study by Edelman, who does a Trust Barometer, very highly regarded piece of work. I'm sure you're familiar with it. The most recent one really called into question, corporate commitments to diversity and really shone the light on it, because people are starting to see what we've just talked about, which is, is this window dressing are really going to be any change?
Felicia Shakiba 18:13
And I'm curious, what was the impact of that study?
Shelly Carlin 18:16
Literally, it just came out in the last two weeks?
Felicia Shakiba 18:18
Oh my goodness.
Shelly Carlin 18:19
Yeah, I think it's been a kind of a shock to a lot of folks, I was in an actual meeting of Heads of Total Rewards, doing some blue sky thinking when this study came out. And there really wasn't a lot of surprise in the room, but more discouragement, you know. We just have such a long way to go, and we can't seem to generate any progress. Bringing this back to the topic of executive compensation, you know, I think companies that think putting a metric in their incentive plan is going to be the magic bullet to improve their diversity and inclusion performance. That's not likely to happen. It's not likely happened. Compensation generally is not that effective when it's used to lead change. It's more effective when it's used to reinforce change that other elements of the company, other systems, other processes, cultural change, competition can reinforce that, but it's not usually an effective tool for leading.
Felicia Shakiba 19:10
On that thread, some argue that a CEOs compensation should be tied to the compensation of their employees to ensure fairness, which really is the root of DE&I and what are your thoughts on this idea? If you could expand more? I know you've touched on it already.
Shelly Carlin 19:27
Oh, it's a great question, because fairness in the eyes of which stakeholder, the employees as a stakeholder. That fairness argument is clearly coming from an employee stakeholder perspective, and understandably so. The question then becomes going back to our stakeholder model, there's two ways to ensure let's just say you wanted to ensure fairness by setting a ratio is a ratio that the CEO pay could not be more than a certain ratio of the average worker's pay. Well, we all know about basic math, right? How do you get that ratio in line you can either raise the average worker pay, which, if you did that, that would cost a lot of money, that money would come out of profits. So one of your other stakeholders, ie investors would not be happy about that, right? So you're you're satisfying the employee stakeholder at the expense of the investor stakeholder.
Shelly Carlin 20:14
The other way to do it, you don't have to raise pay and put all this cost in your system, you could just cut the CEOs pay, which probably you would not have that CEO for very much longer, which also is not a very popular thing with investors. They don't like abrupt CEO transitions, and certainly not because you chose to pay the guy [or girl] less. It all comes back to who is the primary stakeholder and whose interests are first in this whole concept of fairness. And as I said, corporations are under more pressure than I have ever seen, to take account of the interests of these other non investor stakeholders. And what I think we've seen is them trying to do that, but doing it in a way that is maybe not delivering results, certainly not fast enough, and almost worst that you tried and failed than if you hadn't tried at all. Although I love the practice of executive compensation, I started there in my career, it's not for the faint of heart, it is a tough road. And, I will put the CHRO in that because the CHRO is responsible for orchestrating and leading this process with the board.
Felicia Shakiba 21:17
Well, let me ask you this, what is the incentive for a CHRO, or even executive to give in to these requests of fairness? I mean, obviously, they are "feel good" and there are definitely studies that show diversity, equity, and inclusion could ultimately provide greater performance from people in the organization and therefore increase the performance of the organization itself. But it doesn't sound like they're very motivated to do that, especially if the stakeholder that they're trying to please or the greatest stakeholder with the greatest voice are the investors and their focus is the cash understandably, how do you navigate that? And what is the future hold? And really, what does that motivation look like today and tomorrow?
Shelly Carlin 22:11
Two things to keep in mind here, one, the investors primary because the CEO serves at the pleasure of the board. So you clearly are going to put the interests of your boss and who they represent first, so investors and mass can get you fired if you don't perform. But, I think even more importantly, I'm going to refer back to this Edelman study, because many of us, and I'm sure many of us listening to this conversation, truly believe and have the data to kind of support the idea that diverse workforces inclusive workplaces actually do drive better performance. If you go back to that Edelman survey, there's a question in there, that was quite discouraging, which basically said executives generally believe that less, I want to say maybe a third of them believed in the value of diversity and inclusion in positive benefits that that can result to an organization. So I think underneath this all is, do the executives themselves believe in DE&I and the outcomes?
Going back to what I said before, whatever's in your pay program needs to be the things that you believe are going to drive long term value.
And if the executive him or herself doesn't believe that a diverse workforce and inclusive workplace fairness inside the workplace is going to drive business performance, then you know the answer to how they're going to view it, and what a priority or not, they're going to make of it.
Shelly Carlin 23:31
So the thing I love about exec comp, again, we talked about how difficult it is and how you navigate it. I love it, because it is the center of so much that's going on both in the corporation and increasingly in society. We have the saying in the rewards profession, it's the table where it happens. It's the room where it happens, where strategy and what's going on externally, and the board and the CEO's performance, it all comes together and gets played out, in many cases in the conversations around executive pay.
Felicia Shakiba 24:00
And the pay for performance model is being questioned in terms of its effectiveness and the impact it has on executive behavior and business performance. So what are your thoughts on the current model? And do you believe it needs to be revised or replaced?
Shelly Carlin 24:15
Pay for performance is the fundamental if there's anything in common across all of exec comp it is the pay for performance mantra and model that pay shall be tied to performance and aligned in the interests of the shareholder. And I think in the in the main that has been a positive thing. But I think how we've translated that into designs, we're maybe outlived its usefulness and what I mean by that is we basically in executive compensation have very specific components of pay. And all of those specific components are tied to a specific measure or measures of performance. Generally speaking in annual incentives plans, there's two to three metrics that are embedded in those plans. Long term plans is typically one total shareholder return maybe two. So what we've done at the senior level, the senior most level is we've not only said we're going to pay for performance, we've said specifically exactly what we want you to do, which is drive earnings or cash flow, or TSR, or whatever. The problem with that becomes the very people who should be behaving as owners, the top of the house, we've actually treated them more like hired hands, meaning we're going to pay for a specific outcome versus paying you to behave like an owner and look at the entire enterprise, as if it were your own. Owners of small businesses, if you think about it, that way, they don't pay themselves on this metric or that metric, they make decisions in the best interest over the long term that's going to grow the value of the enterprise. Think about it. We do not do that with executives in corporate America, we say specifically, here's the things we're going to pay you for, which again, to me separates them from the ownership mentality that we- that I think we need to be encouraging.
Shelly Carlin 26:04
If I were to kind of reframe this, we were just having a conversation, as I mentioned, with some Heads of Total Rewards about what could be coming in the future. Maybe we need to rethink pay for performance and flip it meaning let's just treat executives like owners. Forget all these arguing over specific metrics. Is it in the plan? Is it not in the plan?- instead of rewarding people based on every year's cash flows, let's give him a long term incentive, that says, you have this much stock and if you grow the value of the business by doing the right thing, and that right thing might be creating a diverse workforce, it might be investing in training and development, it might be hard decisions, like closing plants and facilities and reinvesting in new business. Whatever those decisions are, over the long term, you are going to win when you make the right decisions for the long term health of the business. I think that's more consistent with a multi stakeholder model than what we have today. Because it does then allow managers to not have to defend every day, yeah, I'm going to actually invest in inclusion and diversity, I am going to invest in training, I am going to invest in the environment, they don't have to defend that every day and whether it's in their pay plan or not, or in the court of public opinion. These things are in the right long term interests of the business, let them do that, you know, they will reap the benefits over time. Your goal and your incentive is to make this company worth as much as you can make it worth in terms of growing the value of the enterprise. And how you do that is up to you. We're not going to grade you every year because we think about it what how are we how do we use compensation in this country, we use it as a means of performance management. It's how we manage performance through pay. Instead of managing performance by managing performance, we let pay serve that purpose.
Shelly Carlin 27:53
And I think if I were to start over with a blank sheet, I would say let's get back to actually coaching and evaluating and talking to people about the performance, executives, and not letting the pay plan do that for us. Let's just give them a stake in the business, give them an ownership position and tell them over time you're you're going to be rewarded by driving the value the enterprise, not every year by getting an earnings per share target that oh, by the way, your investors pretty much know that you're only going to set goals that you know you can meet.
So there's a lot of skepticism about that. So long answer to your question. But I think rethinking this whole way that we align the interests of management with the interests of the shareholder is really a fertile ground for I think, some more conversation.
Felicia Shakiba 28:39
What haven't we discussed today that you feel is really important for our listeners to know?
Shelly Carlin 28:44
CEOs control the fate of workers. So we ask the question in this way, we ask, why do CEOs get so much screw knew when sports figures and entertainers don't nobody criticizes what LeBron James makes, but they are attacking CEOs left and right. And the answers that we get are well, CEOs control the fate of a lot of people. One person said pro athletes don't lay off my dad. So this idea that CEOs are subject to more scrutiny because they control the bits of other people is important. There's also a view of with respect to entertainers and sports figures. The clear differentiation of their individual talent and the view that they are performing as individuals it is them and their talent versus the perception that a CEO really, you don't really know what a CEO does, and for sure, they're not getting things done themselves. It's through all these hundreds and thousands of workers. So there's this perception that they don't really do any work. They are making this off the backs of everybody else that does the work and also symbolizes kind of a lack of understanding of the CEO role and a perception that actually anybody can do that. It's also culturally acceptable to say, yeah know, my boss doesn't really do anything, I do all the work. So there's kind of that cultural thing to it. But then finally, I think CEOs are the easy target for populist discontent or sentiment around A levels. I'm not saying that the sentiment is wrong or misplaced at all. I'm just saying that CEOs happen to be an easy place for that feeling to go.
Felicia Shakiba 30:15
Shelly, this has been wonderful. Thank you so much for being here.
Shelly Carlin 30:19
I've enjoyed it. So thank you again for having me. It was fantastic.
Felicia Shakiba 30:23
That's Shelly Carlin, the Executive Vice President at the HR Policy Association, and former SVP of HR and Communications at Motorola.
Felicia Shakiba 30:40
If you like today's podcast, we have more podcasts on innovative HR strategies, talent management, organizational culture and more, and how to navigate the complexities of modern day HR. Find them at CPOPLAYBOOK.com/podcast or search CPO PLAYBOOK on Apple podcasts, Spotify or wherever you listen. Thanks for listening to the CPO PLAYBOOK podcast. We'll be back with a new episode next time. I'm Felicia Shakiba.
Felicia Shakiba 31:14
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