Executive compensation policies and how to create them are among the major corporate governance issues institutional investors wrestle with, according to a new survey from Pensions & Investments and Vivient Consulting LLC, El Segundo, Calif.
"Investors have been focused on executive compensation for the last couple of years and will continue to be this year and into the future," said Gregory Taxin, chief executive officer of proxy research firm Glass, Lewis & Co. LLC, San Francisco. "It is an issue that serves as both a signal for how good the board of directors is and how vigilant the board is being about protecting shareholder interests."
At a time of heightened corporate accountability, nearly 9 out of 10 survey participants said the level of executive compensation is important or very important when evaluating a company. Moreover, 78% said long-term cash-based incentives would encourage better performance than common alternatives such as restricted stock and stock options.
Long-term cash-based incentives are "great because they tie to specific financial goals rather than tying executive compensation to stock price, which fluctuates by the market," said Susan Schroeder, a partner at Vivient Consulting.
Corporate scandals over the past few years have spurred shareholder activism, not only with efforts to rein in pay and promote fiscal discipline, but also to tighten voting policies and realign board structure.
The survey results take into account input from 100 pension funds, money managers and hedge funds regarding their views on governance practices at portfolio companies. Pension funds made up half of respondents, while money managers (20%), hedge funds (20%) and other types of firms (10%) rounded out the pool. More than half of the respondents had more than $1 billion in assets.
In addition to executive compensation, respondents said they are concerned about director accountability and the accuracy and transparency of financial reporting.
One tricky area centers on "pay for performance," or how to measure the performance component in compensation programs. When asked how they establish if a company's compensation is truly pay for performance, 28% said they look to a "transparent, measurable link" between performance and salary. Another 28% said they evaluate industry peer comparisons, while 19% said it is too "difficult to determine." About 14% said they rely on incentives based on "meaningful performance measures that can't be manipulated," such as return on investment.
"You have to allow for different circumstances and what's happening in the market and economy, and it's not often black or white," said Richard Koppes, of counsel at law firm Jones Day in San Francisco and a former deputy executive officer and general counsel of the California Public Employees' Retirement System, Sacramento.
Another area of concern is how to evaluate employee and executive stock option costs, and several respondents said they use more than one method. For example, about 26% employ the "as-reported" accounting expense number reported under Financial Accounting Boards Statement No. 123. Another 21% look at the equity overhang, or the number of shares available for grant plus options outstanding. About 10% said they calculate their own expense number based on their own assumptions.