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TRENDS AND ISSUES 

Staying One Step Ahead: The “New” Top Ten Issues in 

Executive Compensation 

Perhaps the best motto for Compensation Committees these days is, “Be Prepared.” 

Simmering complaints about executive pay tend to come to a boil whenever the 

economy stumbles; and the past two proxy seasons of expanded disclosure have 

provided current critics with new ammunition. More than ever, Compensation 

Committee members can expect and should be prepared to respond in detail to 

questions about their oversight of executive pay programs. 

Among the biggest topics of attention: 

1. Say on Pay. The fate of a bill before Congress to mandate a nonbinding proxy vote 

on executive compensation plans may rest on the November elections. However, 

shareholders at many companies are not waiting - Say on Pay resolutions were filed by 

investors at more than 90 companies in 2008 - approximately 50% more than a year 

earlier. 

Proponents argue that giving shareholders a direct voice in pay decisions will force 

Compensation Committees to do a better job linking pay to performance and reduce 

instances of excessive pay. Critics respond that mandatory Say on Pay would wrest 

control from Directors, without providing any direction as to how programs should be 

changed. Ultimately, they fear that it will put some companies at a competitive 

disadvantage in attracting and retaining top talent. 

However, savvy Boards won't wait for Congress to vote on Say on Pay or for their 

shareholders to take matters into their own hands through a proxy initiative, in order to 

prepare for Say on Pay. They will take the time to define Board members' positions on 

the issue, address potentially problematic aspects of current pay programs, ensure they 

have good lines of communication with shareholders and avenues for feedback/input, 

and be prepared to craft a thoughtful response should their company be targeted by 

investors. 

2. Corporate Governance. Many of the biggest personal and financial risks for 

Compensation Committee members serving in an era of such close scrutiny are the 

unknowns: embarrassing revelations that can blindside Directors and undermine 

shareholder confidence. One of the most effective ways Compensation Committees can 

minimize the risk of being caught off-guard is to focus more closely on the simple basics 

of sound corporate governance practices and processes. 

©2008 Pearl Meyer & Partners, LLC

As a start, Compensation Committee members should address the following questions: 

• Is there a Director-driven process for making decisions? Do members or 

management control the Committee's agenda? How does the Committee ensure it 

is getting all relevant information? 

• Do members truly understand how programs work, especially basic but key points 

such as how competitive data is used and the sensitivity of payouts to variations in 

stock price and corporate performance? 

• Does the Committee have an easily accessible institutional memory? Is there 

continuity from meeting to meeting such that new Committee members can be 

effective immediately? 

• Does the Committee regularly evaluate its own effectiveness and the effectiveness of 

each Committee member? Does the Committee evaluate the effectiveness of its 

compensation consultant and the governance process in general as it relates to 

executive compensation? 

3. Post-Separation Pay. Some of the most damaging headlines related to 

compensation in recent years have involved executives, often at financially troubled 

companies, receiving significant separation packages when they departed. The practice 

has become even more controversial in light of revised proxy rules, which require 

detailed disclosure of the value of such awards. 

Many companies are reconsidering whether cash-severance for executives is routinely 

necessary or even appropriate, especially if the executive has been with the firm for 

several years and has already accumulated significant wealth from the company. 

The tide may be turning, slowly. Over the past year, more companies have made or 

have considered making changes to long-established programs, in some cases by 

putting a cap on severance multiples based on the number of years the executive has 

held the position. Companies have also given more consideration to sunset provisions, 

in which the severance multiple declines as tenure increases. 

4. Change-in-Control Pay. A related and increasingly controversial element of 

executive pay programs is change-in-control arrangements. In an earlier attempt to curb 

perceived abuses, congress, in 1984, imposed a 20% excise tax on change-in-control 

payment that exceed three times the average value of an executive’s pay over the 

previous five years. In response, however, many companies began providing gross-ups 

that essentially reimbursed the executive for any excise tax owed and shifted the tax 

burden from the executive to the shareholders. 

Critics point out that the cost of a gross-up to the company can outweigh the benefits. In 

some cases, the value of a gross-up can approach millions of dollars, plus the company 

cannot take a tax deduction on the excess payment. Recently, some institutional 

shareholders and activist groups have taken the position that a gross-up is a poor and 

unnecessary compensation practice and are going so far as to recommend “against” 

votes for Committee members that implement such a practice. 


Some shareholder groups are also taking the stance that "single trigger" provisions, 

which allow equity awards to vest immediately upon a change-in-control, are another 

example of egregious pay. As a result, "double trigger" provisions, in which the vesting 

of equity awards accelerate only if the executive is actually terminated following a 

change-in-control, are considered the best practice. 

5. Pay-for-Performance. Pay-for-performance can be difficult to define, but with the 

drive to improve Board and Committee processes, posing some basic questions can 

provide a helpful framework for dealing with this complex issue: 

• Are performance standards absolute, or evaluated relative to other companies? 

• How is "pay" defined - is it on an annual basis or cumulative? 

• How is performance defined - is it an increase in total shareholder return, return on 

investment capital, total revenue, or another metric or a combination of metrics? 

• Is performance assessed over the short- or long-term? 

• To what extent will changes in stock price or financial performance affect short- and 

long-term payouts? 

• Are performance metrics focused on the most important factors for the company and 

within the industry? 

6. Expanded SEC Disclosure Rules. Now in its second year, the SEC's heightened 

standards for reporting of executive compensation programs remain a work in progress. 

While this year's disclosures were better in some respects over the year before, there is 

still much room for improvement. For example, criticism by the SEC that many 2007 

disclosures were overly long and hard to understand produced little improvement in 

2008, according to a recent study by Pearl Meyer & Partners of 50 early filer companies. 

The study found that at the median, firms’ Compensation Discussion & Analysis sections 

were actually 13% longer than the previous year, while the median number of pages 

swelled by nearly one-third. Similarly, tests of readability suggested no progress toward 

meeting the SEC’s “plain English” standard. 

Further, the study suggested that while more companies opted to disclose performance 

goals this year, a significant number of firms opted not to disclose this information. Of 

the firms that did not disclose performance goals, few made the argument that 

disclosure would result in competitive harm to the company. It is anticipated that the 

disclosure of performance goals will remain an SEC focus, along with the disclosure of 

how compensation decisions are made and why. 

Of note, in a related Pearl Meyer & Partners study of companies’ views of the 2008 

proxy disclosure process (2008 “Proxies that Make the Grade” report), companies 

indicated that concerns about how programs will be perceived by investors have 

prompted design changes to short- and long-term incentive programs. 

Both the 2008 “Proxies that Make the Grade” and “Early 50 Filers” reports are available for download at 

www.pearlmeyer.com. 


7. Benchmarking and Setting Pay. Compensation Committees recognize that it is no 

longer sufficient to tell shareholders a CEO deserves above-market pay just because he 

or she is talented and hard to replace. Good governance demands that compensation 

decisions are defensible and not made in a vacuum. However, under the intense 

scrutiny of shareholders, there can be a tendency for Committee members to rely too 

heavily on competitive market data. Committees should avoid “chasing the data” and 

feeling compelled to mark to market just because their company’s general philosophy is 

to target, for example, the 50 th percentile. The talent market is a place where the value 

to the beholder is determined by more than price alone. Rather than relying entirely on 

competitive data, Committee members can and should use good business judgment and 

take into account factors such as the executive’s experience, skills, and contributions, 

the company’s performance relative to its peers and whether the business model, 

organizational structure, and executive’s responsibilities are truly comparable to the 

peers/market. These perspectives can point to the need to adjust pay in either direction, 

upwards or downwards. 

8. Internal Equity. Expanded disclosure has put a spotlight on internal equity, giving 

shareholders more insight into the gaps that may exist between the CEO’s pay versus 

that of other named executive officers. Further, more detailed proxies have opened 

executives’ eyes to what their superiors and peers in other companies are paid. Boards 

that ignore major and unexplained differences in pay risk losing top talent, causing rifts 

among executives, and receiving negative shareholder attention. 

9. Consultant Independence. There are two main aspects of the consultant 

independence issue: one is the reporting relationship of consultants with Committee 

members and management; and the other is the types of services provided to the 

company. The consultant independence issue was a major focus in the recent Waxman 

Congressional hearings on executive compensation. Corporate governance experts, 

institutional investors, CEOs of large companies, and compensation consulting firms 

testified in front of a House subcommittee regarding the role of consultants in setting 

executive pay and efforts to prevent and manage real and perceived conflicts of interest. 

Company Boards have taken notice and have begun to stress this issue in order to avoid 

the potential of a “front-page” effect. In a study of recent proxy filings, some interesting 

statistics were found regarding how companies are disclosing the relationship they have 

with compensation consultants: 

• In both 2007 and 2008, 90% of companies said their compensation consultant 

was retained by the Compensation Committee, rather than by management. 

• 12% of companies in 2008 specified that their compensation consultants were 

independent, provided only compensation-related services to the company and 

had no conflicts of interest - up slightly from 7% in 2007. 

• About 81% of the firms provided a description of their compensation consultants’ 

services, up from 73% in 2007. 


10. The "How Much is Too Much?" Issue. No one has come up with an absolute point 

at which an executive is universally said to be overpaid. Generally, investors have not 

objected to executives being handsomely rewarded, provided they spread the wealth in 

the form of increased shareholder value. The most notorious pay scandals have 

typically involved unusually high compensation provided when shareholders saw 

relatively little benefit, either because the results achieved weren't significant or 

impressive results were later discredited. Generally speaking, Compensation 

Committees have a good sense of whether pay packages being provided are 

disproportionate, or truly in line with the value the executives have provided to the 

company and its shareholders. 

While examples of egregious pay still do exist, two relatively easy ways Committees can 

minimize the frequency of these instances is by implementing and following sound 

corporate governance practices and regularly examining the competitiveness of 

executive pay programs and practices. In combination with competitive assessments, 

other ways Committees can reduce the risk of excessive pay is by examining executives’ 

wealth accumulation and conducting “forward looking” analyses - such as an economic 

impact analysis - where potential payouts for executives are modeled out based on 

projected or assumed corporate performance and stock price appreciation. 


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