Blog of Intellectual Capital

By Ronald C. Coelyn – Founding Principal of The Coelyn Group and Gerbsman Partners Board of Intellectual Capital Member.

Earlier this week I read an article in “Agenda,” a publication specifically for Corporate Directors of public companies, called “What’s in Store for 2010 Compensation” written by Josh Martin that I thought might be particularly helpful as executive management turns it thoughts to the upcoming year. The article follows:

Compensation committees at leading corporations are taking a tough stance on executive pay packages, reflecting uncertainty over the economic recovery and concerns that large pay increases could prompt more government regulation as well as shareholder anger.

According to the results of Agenda’s “Directors and Officers Outlook: Q4” survey, 55.7% of independent directors expect to see either no changes in CEO total direct compensation or compensation increases of less than 5% in 2010.  However, there are signs of optimism: More than 66.5% do expect some kind of compensation increase to be approved. (Total direct compensation includes base salary plus annual incentives plus long- term incentive present value, based on value at date of award.)

The low rates of increase reflect the slowness with which the U.S. is moving out of the recession. “Compensation packages reflect the state of the economy,” says R. Charles Moyer, a director on the board of King Pharmaceuticals. “It’s tough to argue for pay increases amid layoffs. Most sensible managers understand this.”

Some directors, especially in industries under scrutiny, point out that the reluctance to give larger pay increases is driven by the new political landscape in which companies operate. “If we gave large raises, regulators would not look on it favorably,” says Lowell Hare, an independent director serving on both the audit and compensation committees at First State Bancorporation.

But there are a number of executives who expect to be rewarded for enabling their company to successfully weather the recession.

A recent poll of 150 CEOs conducted by the ExpertCEO blog site shows that, as a group, they anticipate a bounce of nearly 7% in 2010 total compensation above 2009 levels. The largest increases in CEO pay are expected in the technology sector, where top management is anticipating an 8% growth in total compensation. This is roughly double the average rate of increase forecast by the 131 independent directors participating in the Agenda survey.

The gap between managements’ and boards’ expectations could create some conflict as 2010 pay packages are being finalized. However, boards have a distinct advantage in designing compensation plans that hold the line on increases: In a weak economy, management arguments that pay increases must be given to retain talent carry far less weight.

“You have to be willing to let someone go if you can’t satisfy their pay expectations,” says Paul Rowsey, a director on the board of Ensco International.

Rowsey adds that directors will be “much more deliberative and analytical in reviewing 2010 compensation packages. “They’re doing more research,” he says. “And they’re requiring consultants to do more, too.”

A Checklist for 2010

Consultants themselves are developing proactive strategies to meet the challenges of designing the 2010 executive compensation packages. Mercer, for example, developed a “10 for 2010” list of key actions compensation committees can use to effectively improve the pay packages. These points include:

Reexamine total rewards strategies to ensure their alignment with business strategy.

Make pay for performance meaningful, incorporating new performance measures as needed, to further align performance with business strategy.
Rethink the mix of compensation vehicles, in particular to ensure a balance between pay vehicles, performance time horizons and risk.
Carefully review any compensation actions made during the economic downturn in 2008-2009 to determine which remain relevant and should stay in effect for 2010.

The LTI Factor

Much attention will be paid to the largest area of executive compensation: long-term incentives.
“The current economic climate has made all boards and comp committees rethink all factors that determine incentive pay,” says Hare. “You’re not going to see significant pay increases until [management] stabilize their companies and the general economy strengthens.”

In the face of mounting pressure from management as the economic recovery continues, boards are looking to adjust LTI packages.

Some directors question the growing use within LTI of new pay vehicles, such as performance shares, in lieu of options or restricted shares. “Performance shares do have a place [in LTI packages],” says Moyer. “But there’s nothing you can’t do with other instruments.”

Nevertheless, Rowsey notes that LTI will likely emerge as the area where differences in board- designed pay packages and management’s expectations are reconciled. “Boards will offer performance-based LTI,” he says, adding a caveat: “There will need to be more validation over time for any such increases.”

Tightness Across the Board

The same approach applied to LTI is being developed for bonuses. “We have flexibility to reward outstanding work or give less to those who underperform,” says a CEO who is also a board member. But he adds, “In the current economic environment, even if an executive outperforms, getting a salary increase is not a slam dunk.”

“There’s always difficulty in structuring short-term and long-term incentives,” says Moyer. “There’s no magic formula.”

Directors know they face a unique challenge as they design executive compensation packages for 2010. They need to decide whether to restore last year’s cuts and changes to their compensation programs or carve a new path going forward. In some ways, there is little choice: Activist legislation, regulation recently put in place and an uncertain economy make any “business as usual” approach untenable.

Warmest regards,

Ronald H. Coelyn

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