WorldatWork Total Rewards 2018 Conference Roundup

Equity Methods attended the WorldatWork Total Rewards 2018 Conference in Dallas from May 21—23. We spoke in five different breakout sessions, covering a wide range of compensation and executive compensation topics. Below are a few key takeaways from those sessions.

Gender Pay Equity: What You and Your Committee Need to Know

Pay equity has quickly become a pivotal, game-changing topic—not only in the field of compensation, but also the broader human capital space. Takis Makridis, Blair Jones, and Brit Wittman (Chevron) gave an overview of pay equity before going into the forces making it a top priority and how companies go about performing a pay equity study.

While legislation—including a patchwork of laws in the US and mandatory reporting in the UK—has raised some interest in pay equity, it’s really being driven by two organic forces. First, compensation committees are taking a greater interest in talent as a whole and are keen on making sure effective processes exist for developing and compensating talent. Second, shareholders are forcing the issue through proxy proposals and a push for voluntary and proactive pay equity disclosure.

The panel invited the audience to ask questions, and the 300-plus attendees raised queries on a wide range of topics. Some questions were about ways to measure and test for pay equity problems. Others asked what remediation steps might look like if a problem is identified.

Pay equity is an issue that extends beyond compensation, touching on questions of:

• Representation (enough women and minorities in leadership roles)
• Recruiting (enough women and minorities in entry-level roles)
• Talent development (career progression)

For now, many firms are focusing on compensation. That’s a good starting point where there’s a wealth of data to leverage in performing analyses.

A pay equity analysis of compensation uses multiple regression analysis to explain all the factors behind pay. When pay differences exist that cannot be explained by factors like role, tenure, location, or performance, there could be a problem meriting closer investigation.

The session concluded with a discussion of how companies use the results of these analyses to inform change. Whereas some aim for formulaic pay adjustments, an emerging best practice is to engage with business unit managers to discuss the findings of an analysis and potential compensation or training adjustments.

CEO Pay Ratio, Year 1: Lessons from the Front Lines

The first wave of CEO pay ratio disclosures is behind us. Now companies are reviewing the results, both to benchmark themselves and to plan for the future. David Outlaw joined Wells Miller and Angel Alamo (Walmart) for a discussion of lessons learned from the perspectives of a consultant, attorney, and practitioner.

A common pattern among companies’ methodology decisions was pragmatism. While methodologies might differ between a small, domestic-only company and a behemoth like Walmart, many were borne out of a desire to be reasonable and compliant without being overly burdensome. This drove many companies’ decisions regarding the determination date, the consistently applied compensation measure (CACM), and the use (or not) of exemptions or sampling.

Other than data analysis and calculations, the other major area of focus for companies was on internal and external communication. Internally, the overwhelming experience of both the panel and the audience was that the employee response was muted. While most companies had communication plans ready in their back pocket, they simply weren’t needed—perhaps because the disclosure did not add much new information that was not already available through Glassdoor, Salary.com, Payscale, and such. Externally, most companies took a minimalist approach to the disclosure itself, stating the required information and placing the disclosure outside of the CD&A section of the proxy.

Looking forward, the panel agreed that year-over-year changes are likely to be important. While practices and disclosures are likely to begin converging, any changes to the methodology or the result are likely to draw added scrutiny in future years.

How to Design the Right Performance-Based Incentive Plan for Your Organization

The Tax Cuts and Jobs Act became law in December 2017. Between this and the tension that Say on Pay has created among compensation committees, executives, and shareholders, many companies are taking a new look at the way their performance-based incentives are structured. Nathan O’Connor, David Bixby, and Shane Tucker examined the key issues companies should think about when designing a performance-based incentive plan for their employees.

The usual design problem is that recipients want to receive more value while shareholders are concerned with whether too much value is being granted and whether the link to performance is tight. The compensation committee is tasked with balancing these competing concerns. All of the moving parts mean that companies generally give themselves at least six months of lead time before issuing a new award.

They also face a choice between market-based performance awards and financial- or operational-based performance awards. Market awards require Monte Carlo simulation for valuation purposes, but provide issuers with static expense accruals. Metrics can include total shareholder return and the company’s stock price.

By contrast, performance awards with financial or operational metrics don’t require a financial model to determine the expense. However, they do result in variable expense accruals. Metrics can include EPS, EBITDA, economic value added, return on capital, and other operational or strategic milestone measures.

An increasingly popular practice is to create a hybrid award. These awards combine the shareholder-friendly aspects of market awards with the line of sight that financial and operational metrics provide.

Finally, companies should always be sure to structure their awards to be compliant with relevant laws and regulations, including IRC 409A and 162(m), especially in light of recent tax reform.

ROIC: The New Performance Metric of Choice?

Companies constantly search for performance metrics that yield closer alignment to shareholder value creation and line of sight for executives. To that end, more have been turning to return on invested capital (ROIC). Takis Makridis, Eric Hosken, and Jennifer Mackin (Ferro Corporation) led a session discussing the ins and outs of this metric.

ROIC is a capital efficiency metric not dissimilar to metrics like return on equity (ROE) and return on assets (ROA). Shareholders have been promoting capital efficiency metrics, especially ROIC, because they relate a firm’s earnings to the capital required to generate those earnings. In this regard, ROIC holds business leaders accountable for making disciplined investments.

Jennifer shared a case study that involved installing a ROIC metric (plus a TSR modifier) in 2013. This occurred as the company was seeking to make acquisitions and charging executives to think carefully about the best way to use the firm’s investment dollars. The metric helped create a common language around investment returns and efficiency, a topic into which leaders already had line of sight given the broader strategy conversations they took part in.

Of course, no metric is perfect and without risks. One shortcoming associated with ROIC is that investments usually last much longer than the typical three-year LTIP performance period. Any given year’s ROIC measurement could be clouded by investment time horizon problems. For this and similar reasons, there’s no alternative to rolling up your sleeves and stress-testing what types of events can reduce metric line of sight.

Hot Topics and Evolving Equity: Changing LTI in a Changing World

Equity and executive compensation are constantly changing. Practitioners need to stay in front of best practices. During this session, David Outlaw, Tim Bartl, and Dmitry Shmoys (Dr Pepper Snapple Group) examined an array of emerging issues in this space.

First was the communication of long-term incentive awards—critical to helping participants understand their awards and avoid a disconnected “lottery ticket” effect. Best practices for grant communication include the use of clear, graphical examples rather than dense text. Best practices for post-grant communication included granular detail about how specific business outcomes tie each moving part of the long-term incentive program to on-the-ground results.

Next up was tax reform. While certain details will remain unclear until the IRS issues additional guidance this summer, the expectation is that most companies will take a cautious approach in order to avoid unintended consequences. For example, greater discretion can lead to onerous mark-to-market accounting. Also, adjustment of EPS goals for midstream performance awards can cause these awards to lose their grandfathered exemption under 162(m).

Finally, the group discussed optimal usage of equity plans against real-world constraints. With labor markets hot as they are, equity awards are needed to attract and retain talent. But shareholders and governance groups impose limits on the number of shares that can be issued. This means that companies need to make smart reductions and maximize the perceived value of grants.

Examples of smart reductions include investing more equity in strategically important roles versus others, as well as the use of alternative plans like ESPPs to fill the void left by traditional equity becoming less broad-based. Examples of maximizing perceived value include the use of shorter or graded vesting schedules to deliver value faster, designing plans to have good line of sight and linkage to corporate strategy, and emphasis on clear and frequent communications.