Is ISS, and other governance watchdogs, leading us to mediocrity and sub-par shareholder returns?
Speaking at a recent NACD North Texas event, Marc Hodak, noted compensation advisor, teacher at NYU Stern School of Business, and CEO Trust member, promised we would hear something we had never heard and he completely fulfilled that promise.
Co-sponsored by CEO Trust and UT Dallas’ Institute for Excellence in Board Governance, the well attended event provided board directors an opportunity to hear the latest compensation research set in a context of expert and candid advice.
Marc organized extensive research in the field by asking and answering the following questions:
- What is the value of equity to managers?
- What is the value of management equity to investors?
- What to do about “underwater options”?
- How should incentives be awarded?
The research findings for each were startling, especially in the context of most board room compensation discussions today. Boards predominantly “benchmark” their compensation plans asking questions about their peers and ISS guidelines rather than asking key questions about how a plan would truly motivate revenue growth and cost improvements over the shareholders’ investment horizon.
Among the findings, companies with uncapped bonuses significantly outperform their industry peers and no research study has contradicted this. On the other end of the “incentive curve”, thresholds have stimulated extreme behavior to cross the line at best and scandals like Enron and WorldCom at worst. Additional research findings contradicted the standard practices of “non-performance” pay, handling underwater options, budget-based management incentive plans, and others.
Once the empirical data was established, Marc continued by providing a general framework for compensation plans that do, in fact, increase shareholder value and properly incentivize management, as well as the entire workforce. They hinge on single metrics such as net income, earnings, or EVA, and support longevity to reinforce profit building behavior.
Marc has elsewhere written, “In a world where every dollar denied to management is thought to be a dollar more in the shareholders’ pockets, the accumulated public company compensation requirements and standards make perfect sense. But in the real world, where costs must be intelligently traded off with retention risk and alignment, SEC requirements and ISS standards get in the way of well-intentioned boards.”
Focusing on standards at the exclusion of research data and market dynamics can lead to unproductive compensation plans. Marc also candidly added that focusing on proxy approval can create continuing engagements with many compensation consultants as the standards ebb and flow.
As directors in attendance, we recognized a need for incentives that truly promise rewards to drive behavior for the benefit of the shareholders. Now armed with new information, we will be wary of an advisor who merely monitors an ISS checklist for proxy support. Instead, we will prefer a research based compensation advisor to help guide the development of a value based plan.
