'Farient principles' could solve problems

As companies continue adjusting their compensation packages to better reflect pay-for-performance models, it has become clear that the way companies define pay is playing a major role in determining whether proxy advisory firms will make positive say-on-pay recommendations.

Until the SEC releases its rules on pay-for-performance disclosures in executive compensation, Robin Ferracone, CEO of executive compensation consulting firm Farient Advisors, says companies should consider using some basic principles for defining pay when developing their pay-for-performance models. Those principles are outlined in a report, ‘Pay definitions: What works best in pay for performance analysis’, released last month.
 
Among the seven principles outlined in the report are common sense measures such as ‘all elements of compensation should be valued after performance has happened, not at grant date’; and ‘the time horizon of the pay components should match the horizon of the performance measured.’ While these principles are not all new, Ferracone argues that they could provide much-needed guidance for shareholders to use when comparing pay and performance. In fact, she asserts, ‘we are suggesting that the principles be the standard.’
 
Ferracone says she had a discussion with the SEC about a year ago about the idea of standards for pay, but since then she has refined her views into the principles in her report, which she intends to share with regulators.
 
‘What I am going to do is send them this in another letter that talks about coming up with principles as a way of pointing corporate America toward a certain direction instead of having everyone trying to invent their own and trying to guess what to do,’ she says. ‘Companies and investors would be better off if [regulators] would put forth some principles they could use as a signpost.’
 
Since the key component of any pay plan is equity compensation, which includes long-term incentive equity such as options grants, a standard clarifying what is most acceptable would indeed be helpful. When judging pay for performance, Institutional Shareholder Services (ISS) generally relies on the Grant Date Value of equity compensation and Glass Lewis appears to be leaning heavily toward realizable compensation when determining what is most fair and accurate. There is wide disagreement on what works best, as individual companies are making decisions on pay based on what works for them, and then trying to explain their rationale to shareholders in the compensation discussion & analysis section of their proxy statements.
 
As companies prepare their disclosures for 2013, Ferracone recommends corporate legal departments, ‘think about the principles on which you want to report pay-for-performance alignment. Try to have some consistency from year to year, try to make it easy for the investor to follow it and make it easy for investors to derive the calculations based on the reporting of the amount earned.’ Having a clearly thought-out approach to pay for performance with clear explanations why it works will help companies win the approval of proxy advisory firms next year.

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