CEO Pay Ratio Legislation Up For Repeal

24 Friday May 2013

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Image Credit: <grist.org

Image Credit: <grist.org>

The Dodd–Frank Wall Street Reform and Consumer Protection Act has 1. I love the requirements around disclosure of pay versus performance, have mixed feelings on the clawback policy, and think the say on pay vote provision causes more problems than it solves. both positive and negative components 1, but one thing I definitely hate about the act is the pay ratio mandate.

The HR Policy Association does a fantastic job of explaining what the pay ratio mandate is, so rather than bloviate about the concept I’ll share its simple(r) explanation below:

The pay ratio provision requires publicly held companies to annually calculate the median total compensation for all employees globally, as defined under the SEC’s executive compensation disclosure rules, and disclose a ratio of the median employee’s compensation to the CEO’s compensation.

I want to point out that I get the public outrage around executive pay (although I don’t agree with it). I also want to say that contrary to the claims on many large cap companies, I don’t think that it would be that difficult for 2. To get an employee population median, a company need only pull a listing of their population’s salaries, sort by country, and do a currency conversion to USD. From there, it’s just a matter of querying the median salary from the data set. Any company with a half decent HRIS could get a reasonable approximation of this number in under a day or so. most organizations to calculate the ratio. 2

Image Credit: <blogs.reuters.com

Image Credit: <blogs.reuters.com>

Yet I am still against the pay ratio mandate for two reasons:

1. I don’t think investors really care about the number

2. The number literally doesn’t matter as it concerns the health of an organization

The 2nd point isn’t an exaggeration. In a May 23rd testimonial before a House Subcommittee, in response to an AFL-CIO claim that “[the bill to abolish the Dodd-Frank pay ratio mandate] is designed to hide material information from investors, encourage runaway CEO pay and increase economic inequality,” Center On Executive Compensation CEO Charlie Tharp pointed out that there is no correlation between company performance and the CEO Pay Ratio. Tharp drew attention to the fact that based on data on the AFL-CIO’s own website, companies it considers to be “great” have a 412.5 average pay ratio compared against a 354 average pay ratio of all S&P 500 companies.

If anything, the evidence points the other way here.

Further, CEO pay represents only a few basis points for most large cap companies. Ergo, cost isn’t a concern either.

The only point of the ratio at this point is to satiate a small slice of the public that is (pointlessly) upset about what executives make. In my opinion, that isn’t a good enough reason to enforce the mandate.

…With all that said, this is going to be a hot button issue for some time to come. I’d ultimately like to see the pay ratio issue put to bed so that companies (and the consultants they employ to advise around this stuff), investors, the media, and analysts can focus on more important things.

As always, please share your thoughts in the comments section below.

Best,

Rory

If you have questions about something you’ve read here (or simply want to connect) you can reach me at any of the following addresses: 

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Perception of Pay is More Important Than Level of Pay

23 Thursday May 2013

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Image Credit: <www.elements2lead.com

Image Credit: <www.elements2lead.com>

The idea that one’s perception of pay is a core component of pay satisfaction is a simple – perhaps even intuitive – concept.

If someone perceives they are being compensated at an appropriate rate then the actualities of the market are almost besides the point.

In point of fact, however, this principle is not in wide use. Companies routinely spend significant sums of money raising pay (base and at risk) to drive performance. What they should be doing is looking at how employees perceive the plan design and tinkering with it in more cost effective ways.

Anna Krasniewska Shahidi has an interesting spotlight on World at Work TV that touches on just this idea.

She goes on to expound on sales compensation best practice (individual performance incentives, team based incentives, the role of compensation 1. It really is a good video (and it’s less than 7 minutes long). I’d recommend watching the whole thing.functions in administering sales comp etc. 1), but what I want to focus on are three core elements of pay perception that she says drive performance:

1. Fairness – Is effort aligned with returns?
2. Complexity – Is the plan design easy to understand?
3. Risk Component – Is the employee population / individual employee comfortable with the level of pay at risk?

If the answer to all three of these questions is yes then one is well on the way to achieving the most difficult – and important – component of effective plan design:

The sense that the employer has the employee’s best interests in mind. 

If a company’s employees believe they are being taken care, the details of the compensation plan just become a series of affirmations supporting that belief.

Or do I have it wrong?

As always, please share your thoughts in the comments section below.

Best,

Rory

If you have questions about something you’ve read here (or simply want to connect) you can reach me at any of the following addresses: 

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Pay Disclosure Leads to More Efficient Markets

22 Wednesday May 2013

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Image Credit: <www.gametheory.net

Image Credit: <www.gametheory.net>

I had a great conversation with a mentor/friend yesterday around (non-executive) pay disclosure. It was a good exchange of ideas, so I’m writing about it here.

My thinking on the subject is that widespread accessibility to pay information leads to more efficient markets in the same way increased accessibility to information improves market efficiency in any other industry.

The current relationship is as follows: An employer wants an employee for as cheaply as possible, and an employee wants to provide their service for the maximum possible rate. As such, when the two parties seek an agreement there is a give and take (i.e. negotiation).

…The thing is, in the market as currently constructed the employer has a lot more leverage than the employee because the employer has greater access to information. I don’t view this as fair or unfair – it is what it is.

With that said, this creates inefficiency in the market place. Instead of the best people working for the employers most willing to pay for (and assumingly generate the most return from) their services, they instead work for the employers who happen to offer the best extrinsic/intrinsic reward package that they know of.

Increased pay disclosure in the labor market would change this dynamic.

I think the executive pay market is a good example of pay disclosure working in the labor arena. Mostly due to government disclosure rules, CEO/CFO pay rates are widely available to anyone interested (one need only make a trip to the SEC website). As such, when a company evaluates a CEO’s compensation for fairness they benchmark against the executive’s peers.

A CEO that is paid below the median of his/her peer group has an easy argument to make for being underpaid since the data on CEO pay is accurate, available in a consistent format, and easily accessible to anyone interested in it. The question of if an employer can afford a particular CEO is a matter of supply and demand – they can pay the market rate for the talent they want or they can’t. If they can’t afford the market rate for the talent they want then 1. There are certainly some real issues with the executive pay structure in the United States (specifically that all employers target p50 or higher which creates a ratchet / lake wobegon effect), but underpay for services rendered is not one of them. If similar disclosures existed for pay philosophies / market rates, we would probably see less pay disparity, and it would largely be because pay disclosure forced employers to pay competitively for positions that they’ve historically been able to underpay for.they look for someone who will work beneath it. 1

As a huge free market guy, I certainly respect and endorse the decision of employers (typically) not to disclose pay information (it’s in their best interest not to), but I also recognize that the lack of available wage data creates an economic environment in which the overwhelming majority of employees aren’t paid a wage in line with the value they add to their respective organizations. 2 This not only creates a market inefficiency that harms the employee, but it also damages the economy as a whole. 3

Competition is good for the market (although perhaps not for any individual company). To see this is true one must only think of how almost 2. There is a great article from the Economic Policy Institute that summarizes the issue well, but in short: Employers are realizing the gains of increased productivity, but most employees’ wages have held largely flat over the past several decades.any other market outside of the labor market works:

Example: If I go into a store I can see the price of every brand of gum in that store. This doesn’t disrupt the competitive balance of the market. Companies charging higher prices compete with lower priced gums based on quality, brand, and shelf space/positioning etc. This same reality holds true for thousands
3. Much of this is also cultural. Employees don’t discuss salaries with one another as it is considered taboo (though this is rapidly changing). Most employers insist employees disclose their current wage before extending a competitive offer (while often refusing to disclose pay range or philosophy on their end). It’s a lopsided arrangement that heavily benefits employers.(millions?) of other products. Consumers go to gas stations and pay premiums for the products there (as opposed to going to supermarkets) because of convenience. People buy technology devices based as much on supplementary product offerings as the price of the product itself. Even in markets where there is a range/unclear market signals (like when buying a car), both parties are on relatively equal footing since a car customer can choose not to disclose the most he is willing to pay (and has dozens of easily accessible online resources that show what competitors are offering for similar vehicles etc.). Only the labor market (and a few others) is fundamentally different here because the value of labor is such a closely held secret.

This guy can't get one over the way he used too. Image Credit: <www.findingbetteragencies.com

This guy can’t get one over the way he used to. Image Credit: <www.findingbetteragencies.com>

If starting tomorrow employees knew more about the value of their labor, in the short term there would probably be a rise in market turnover. Afterward, however, I think the markets would stabilize; employers would both pay more competitively *and* draw more lines in the sand (there would be fewer counter offers) I also think you would see wages as a whole rise… and employers who couldn’t compete on wages would start to compete on fringe benefits / intrinsic rewards instead.

Of course, pay disclosure on any wide scale level is unlikely to ever happen. Employers paying below p50 (and perhaps even p75) would lose far too much talent to competitors if wage info were to become widely available in the way that executive compensation is.

I will say that I think there will be a shift to the center here going forward (with employees gaining more leverage). Gen Y is much more open to sharing salaries with one another. We typically don’t share salary info internally (there is an implicit understanding that there is blowback if the employer finds out), but we share much of this info freely amongst friends outside of our organizations. Much of my social circle is in HR/Marketing/Finance, and we all know one another’s salaries (and the salaries of friends of friends in some cases as well). If someone in my peer group is unhappy with pay it isn’t hard for him/her to learn the names of 10 companies that pay better for similar work. A decade ago those same people would have just had a sneaking suspicion they were below the market average.

Between informal social networks and sites like Glassdoor / Payscale (which are getting cleaner in their data collecting methodology), employees are becoming more educated around pay. Whether that creates any leverage or not remains to be seen.

As always, please share your thoughts in the comments section below.

Best,

Rory

If you have questions about something you’ve read here (or simply want to connect) you can reach me at any of the following addresses: 

SomethingDifferentHR@gmail.com OR rorytrotter86@gmail.com

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85% of Executive Compensation is at Risk

21 Tuesday May 2013

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A common criticism of executive pay is that CEOs make an extremely high 1. According to the AFL-CIO, the number stands at 354 times average worker pay. The statistic is at least a little misleading since it uses realizable pay instead of realized pay, but the point is that CEOs make a *lot* of money. .multiple of the average worker’s earnings. 1

One thing that is largely ignored here, however, is the fact that a large percentage of the average (large cap company) CEO’s pay is at risk.

Image Credit: <http://www.execcomp.org

Image Credit: <www.execcomp.org>

Part of the reason for this large percentage of pay at risk is Section 162(m) of the U.S. tax code. The section came into law in 1993, and it caps tax deductions for compensation at 1 million U.S. dollars. For any additional compensation to be tax deductible on a company’s balance sheet it must be performance based, which basically means that it can only be paid out 2. Increasing shareholder value could constitute a number of things, including (but not limited to) increasing TSR, revenues, market share, profit margins, expanding into a new market, or completion of a major business project/strategy/goal. The key here is that performance based pay is paid out contingent on the CEO doing something that adds value to the enterprise in some way as defined by the board / compensation committee.contingent on achievement of (shareholder value adding 2) goals.

Image Credit: <www.farient.com

Image Credit: <www.farient.com

With that said, while the tax component certainly plays a role for some (perhaps most) companies in determining the percentage of executive pay that is at risk, a larger factor here is that it is in shareholders best interests for executive pay to be driven by performance.

One can argue about the level of performance that should be required for 3. Topic for another day.payouts, and one can also argue about the merits 3 of performance based pay.

If we accept as a starting point, however, that executive pay should mostly be at risk (or at the very least that pay at risk is not going away anytime soon 4), then it makes sense that executive pay opportunities need to be 4. Proxy advisory firms (which have been empowered by the Dodd–Frank Wall Street Reform and Consumer Protection Act) are looking for a strong link between pay and performance as a requirement for recommending shareholders vote “yes” on Say on Pay votes (see Goldman Sachs for a recent example of what happens when a company fails a proxy advisory firm’s performance tests.sufficiently high to compensate for the fact that their earnings are extremely volatile compared to the average worker.

Ultimately, compensation committees are tasked with finding a way to compensate executives fairly (relative to the market as a whole) while at the same time countering social unrest around high pay packages and aligning pay with performance. It’s not an easy task.

Are compensation committees failing here? Does the fact that such a significant percentage of pay is at risk mitigate the high multiple of average worker pay (or does the multiple even matter)?

As always, please share your thoughts in the comments section below.

Best,

Rory

If you have questions about something you’ve read here (or simply want to connect) you can reach me at any of the following addresses: 

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Executive Compensation No-Fault Clawbacks – Fair or Unfair?

20 Monday May 2013

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Image Credit: <www.lexisnexis.com

Image Credit: <www.lexisnexis.com>

First things first. Let’s define what a “Clawback” is:

From Wikipedia:

In finance economics, a clawback is when an organization (typically a financial firm) that is attempting to recover from a catastrophic shift and/or collapse (e.g., the current worldwide financial crisis) attempts to essentially “tame” its past practices by giving its most highly-paid employees bonuses in pay that can be withdrawn, or reclaimed, if the reason for the bonus is later found to be invalid.

In laymen’s terms? If one is a senior executive that’s paid a cash bonus and/or incentive compensation based on high performance that is later determined to have actually been not so high, that pay can can be “clawed back” by the company (i.e. the executive has to repay it).

This sounds intuitively fair. If one is paid a bonus based on high performance that is later determined to have been less than stellar, that compensation should be recouped by the dispensing company as it wasn’t actually earned.

Here is where (for me) things get a bit grey.

The Dodd–Frank Wall Street Reform and Consumer Protection Act has in it a provision that requires mandatory clawbacks of any excessive incentive compensation paid out to executives over the prior three years in the event of 1. You can read a great summary of the change here.financial earnings restatement. 1

The key issues for me here are that:

A. The clawbacks are mandatory.

B. The degree of board discretion here is still somewhat unclear.

I’ve been meaning to get to this topic ever since JP Morgan lost billions on a bad hedge back in 2012. There was widespread discussion of clawbacks to reclaim compensation from those most responsible for the loss. In addition to key executives directly responsible for the loss, CEO Jamie Dimon’s pay was also put on the table for clawbacks (though ultimately only his unvested LTI was reduced).

To his credit, Dimon was 100% open to his earnings being clawed back. With that said, I wonder if he should have been. The SEC hasn’t yet issued guidance on the Dodd-Frank clawback provision here, so the board had the discretion to exercise considerable judgement around clawbacks in this case (and behaved pretty reasonably).

Image Credit: <barbaradenny.com

Image Credit: <barbaradenny.com>

Regardless of what the outcome was there, however, I can’t help but think that any legislation that requires mandatory action be taken by boards / companies around clawbacks is flawed. A no fault provision simply paints too broad a brush, and the legislative intent here (which is to create a greater incentive for senior executives to more closely monitor financial statements / direct reports) doesn’t actually serve its intended purpose.

Executives like Dimon don’t purposely let errors like the 2012 hedge slip through the cracks, so a mandatory clawback provision does little (if anything) to mitigate these sorts of risks.

Ultimately, as long as the SEC continues to take a stance (via lack of additional directives or explicit grant) that boards have broad discretion around clawbacks, I don’t have a huge problem with the provision.

2. Sarbanes Oxley section 304 has similar clawback provisions to CEO and CFO compensation in the event of issuer misconduct, which I think is more than enough.I also don’t think it was needed, though. 2

As always please share your thoughts below.

Best,

Rory

If you have questions about something you’ve read here (or simply want to connect) you can reach me at any of the following addresses: 

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Helicopter Parents Are Wonderful

19 Sunday May 2013

Posted by in General HR, Talent Management

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Image Credit: <parentables.howstuffworks.com

Image Credit: <parentables.howstuffworks.com>

Lately I’ve been hearing a lot about helicopter parents. The thinking among employers seems to be that helicopter parent coddling is an unwelcome (but tolerable) nuisance at best, and a significant hindrance to the employer / employee relationship at worst.

Personally? I love helicopter parents. I think they are wonderful.

1. You can browse her site if you want a clearer picture of why she’s insane, but I think this article serves as a nice enough example. Still, insane or not she is if nothing else entertaining. Penelope Trunk (who as a general rule I think is at least a little insane 1), has a great article on helicopter parenting and why it’s good for children. Long story short? Newly minted college graduates know nothing about interviewing, even less about negotiating a salary / benefits, and the least about being a professional. On the other hand, their parents (who have spent decades in corporate America) know much more about these things and (as such) can more effectively advocate for their children.

Of course employers view new grads not as children but as employees (as they should), and the meddling of helicopter parents creates an unwanted intermediary between two parties that have historically worked directly with one another.

This is not an unfounded criticism, but employers should lighten up and let it go. Helicopter parents will back off eventually. Before doing so, however, they 2. That was at least a little clever, right?want to ensure their little birds know how to fly. 2

As always, please share your thoughts in the comments section below.

Best,

Rory

If you have questions about something you’ve read here (or simply want to connect) you can reach me at any of the following addresses: 

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Using Social Media to Recruit is Challenging Because…

18 Saturday May 2013

Posted by in Compensation, Recruiting

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Image Credit: <www.massrelevance.com

Image Credit: <www.massrelevance.com>

…Life is about relationships.

HR Analyst John Sumser recently wrote a great article touching on some of the reasons that social recruiting hasn’t really caught on.

He makes some very good points, the most powerful of which (IMO) is that social recruiting in its present form hasn’t shown much scalability.

Ultimately, as wonderful as social media has been for the purposes of identifying talent, it hasn’t really made the outreach process any easier. Recruiters can effectively use social media channels to source candidates, but when it comes to actually developing relationships (and gauging cultural fit) social media doesn’t offer anything that more traditional recruiting channels don’t already provide.

This is one reason that even as we find more ways to automate and streamline processes, a good recruiter will always be able to find work.

Social capital is such an integral component of the human experience that those rich in it will always be an asset to firms looking for talent in the external market. This is because real relationships take time, and they take work. They are also finite.

So far social tools haven’t necessarily made the relationship building process any easier (though as stated above they have made finding talent less troublesome). 

With that said, I don’t know what the future of social recruiting looks like… not a clue. Future generations could learn to socialize in an entirely different way The data on how young people will use social media going forward has been mixed.than their forefathers. 1 If so, that will change everything.

…But I’m not convinced yet. At least for the time being, building a relationship via social media channels isn’t faster or more effective than traditional networking.

Good old fashioned human interaction (it seems) continues to rule the day.

Or do I have it wrong?

As always, please share your thoughts in the comments section below.

Best,

Rory

If you have questions about something you’ve read here (or simply want to connect) you can reach me at any of the following addresses: 

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Complexity Versus Scale – Which Has More Compensable Value?

17 Friday May 2013

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Image Credit: <www.philgalfond.com

Image Credit: <www.philgalfond.com>

Earlier in the week I had a fantastic conversation with a friend around complexity versus scale. The conversation essentially centered on which work component had more compensable value. My friend argued as a general rule for 1. It always does. This is not just a cop out because I am compensation guy at heart, either. There are *so* many exceptions to things in HR that saying “this is 100% the answer” is seldom true. complexity, while I argued “It depends.” 1

With that said… the argument for complexity over scale is multifaceted, but a factor in the argument for complexity over scale concerns the number of stakeholders in a complex operating environment (versus a less complex one). More specifically, in highly complex roles there are typically many decision makers that must be influenced to get things done.

Using an HR example (I love HR examples), a Regional HR Manager supporting a 1,200 person client group spread across 4 states and 12 sites will almost always have a more complex job than an HR Generalist / Business Partner supporting a 1,200 person client group made up of a singular function or department. Ergo, in a direct comparison a Regional HR Manager has a bigger job than an HR Business Partner handling similar scope because he / she must influence at least 12 site leads, dozens more departmental heads, and also stay aligned with the corporate HR function. Further, the Regional HRM may have a Business Unit President or Regional Vice President / Director that he or she reports up to. Conversely, an HR Business Partner need only be (theoretically) aligned with his or her direct manager and the functional / departmental head of the client group.

Expounding further on this position, the thinking goes that even if the HR Business Partner supported a much larger client group than a Regional HR Manager (think 1,200 employees in one functional group for the HRBP versus 400 employees across 3 states and 4 sites for the Regional HRM) the number of stakeholders the Regional HRM has to deal with drives the complexity of the role up to such a high level that the scope of the HRBP’s role is minuscule in 2. This same logic could be applied in other instances as well: A site HR Manager supporting a 150 person client group made up of a variety of highly skilled employees (and a bargaining unit) has a more complex job than an HR Manager supporting a 600 person non-union site made up of mostly unskilled labor. The job of the CEO at Exxon Mobil versus, say, Wal-Mart is another good example: The Wal-Mart CEO is the leader of a much larger employee population, but the Exxon Mobil operating environment and business model is arguably more complex. comparison. 2

I certainly agree with the thinking that all other things being equal, complexity rules the day. Where my viewpoint differs, however, is the implicitly stated idea here that stakeholders are principally people empowered by an organization to make decisions.

Once an employee population grows beyond a certain level, the truth of the matter is that multiple decision makers are needed to manage the population regardless of who is a formal decision maker.

These people are all stakeholders.

Figuring out where scale and influence intersect is a difficult point to find. Image Credit: <keeldevelopment.wordpress.com

Figuring out where scale and influence intersect is a difficult point to find. Image Credit: <keeldevelopment.wordpress.com>

Michel Foucault has some great writings on power that expound on this topic 3. This deserves its own post. Another day etc.3, but without diving into the weeds on theories around power and influence, I’ll just say that just because someone doesn’t have formal power doesn’t mean they don’t play an integral role in decision making processes.

An HR Business Partner who supports a 1,200 employee population of salespeople isn’t just concerned with pleasing his or her manager and the department head / President. This is because the department head can’t possible effectively manage a population that size alone. If the Sales President is any good at the job he will have a host of managers and individual contributors whom he leans heavily on when making decisions. Decisions made from the top down impact everyone in the organization, and a good leader has people lower in the organization whom he / she looks to for counsel even if those people don’t have formal decision making power. A good HR Business Partner has to generate buy-in not only from the functional head of the department he / she supports, but also all of the various stakeholders within the department with significant decision making authority. These people may or may not be aligned in the same direction.

Trivializing the impact that informal leaders have on the decision making process based on their place on an org chart is to fundamentally misunderstand the way that decisions are made.

Of course, depending on how a department / function is structured, it’s entirely possible that the number of stakeholders is exactly aligned with what one sees in an org chart. As an example, at a large supermarket the number of decision makers might be an incredibly skewed ratio.

…Like I said, it depends.

When looking at compensable value it’s critical to weight both the complexity and scale of a job in line with the realities of the organization. There are going to be instances in which as a general rule scale trumps complexity, and there will also be instances where the converse is true.

4. I’m having internet issues at home again. We’re floating past 900 words and I’m posting this from a Panera Bread, 4 so let’s wrap it up here.

As always, please share your thoughts in the comments section below.

Best,

Rory

If you have questions about something you’ve read here (or simply want to connect) you can reach me at any of the following addresses: 

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Driving Business Outcomes Through Employee Engagement at Banner Health

16 Thursday May 2013

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Here is an interesting case study I ran across from World at Work. I wanted to share with you:

Please share your thoughts in the comments section below.

Best,

Rory

If you have questions about something you’ve read here (or simply want to connect) you can reach me at any of the following addresses: 

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Effective HR Starts With Listening

15 Wednesday May 2013

Posted by in General HR, HR Management

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Image Credit: <scottpageillustration.blogspot.com

Image Credit: <scottpageillustration.blogspot.com>

1. I’m a bit distracted. My (awesome) company just granted me access to the HR Policy Association and I can’t stop reading all the great links / articles. …Short post today. 1

I just want to share a realization I’ve come to as of late:

The best HR people tend to be fantastic (objective) listeners.

It is very easy as an HR professional to approach a contentious employee situation with preconceived notions around the case facts. To this point, when dealing with discipline / dismissal (where an employee’s history may have some predictive value) the easy thing to do is to assume that performers with a history of poor behavior are guilty as charged, while giving others the benefit of the doubt.

2. If it walks like a duck etc. Schemas 2 are often useful in this way, but where employee discipline is concerned using them as a heuristic is typically a bad idea. The reason for this is because even if an employee’s past behavior is strongly correlated with future actions, in the long run using a kangaroo court approach to administering discipline will cause one to lose credibility in the eyes of the employee population one supports.

Start off assuming the best about people and let them prove you wrong. 

Or am I too trusting?

As always, please share your thoughts in the comments section below.

Best,

Rory

If you have questions about something you’ve read here (or simply want to connect) you can reach me at any of the following addresses: 

SomethingDifferentHR@gmail.com OR rorytrotter86@gmail.com

@RoryCTrotterJr

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