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Improving Small Company Comp Plans for Stronger Performance
Posted By Bertha Masuda and Susan Schroeder On December 12, 2013 @ 6:11 pm In Home Highlight
News Story | 1 Comment
Many small public companies have not established a formal process to regularly review their
compensation programs, tending to put the task of assessing their compensation programs on the
back burner. After all, their boards are often intently focused on driving revenue growth and
improving profitability.
With governance critics increasingly spotlighting weaknesses
such as inadequate pay-for-performance orientation and
excess in small companies’ compensation practices, the
downside of this inattention is considerable and becoming
greater. Not to mention, without a pay-for-performance
orientation, for example, corporate performance may fall
short of its full potential.
Potential critics are viewing these programs through a new
lens created by the SEC’s application of required say-on-pay
(SOP) rules to small reporting companies (those with a
market capitalization of $75 million or less) and emerging
growth companies. Already a fact of life for directors at large
public companies, whose compensation programs have been
subject to nonbinding shareholder votes since 2011, SOP
votes will be held at smaller reporting companies for the
second time in 2014. Program disclosures — in addition to
the disposition and breakdown of the ensuing votes — can
highlight issues for shareholders and serve as fodder for
critics.
[1]
Bertha Masuda
In the SOP votes for 2013, only 1 percent of the companies in
the small public company category landed in the negative red
zone by failing, with less than 50 percent of the vote,
according to Equilar. About 17 percent were in the cautionary
yellow zone, with an approval rate of 50 to 80 percent. And
82 percent were in the favorable green zone, indicating
overwhelming approval, with 80 to 100 percent favorable
votes.
While only a few companies failed to get approval, over 100 companies received lukewarm
approval—a status to be avoided. Moreover, just because a company passed in the 2013 vote does
not it will in 2014.This is especially true if company performance decreases while payouts to senior
executives increase or remain at the same levels.
For many small companies, business strategy and financial goals are dynamic, adjusting quickly to
changes in the market place. On the other hand, compensation programs tend to be more “sticky.”
They are either inherited from past years or handled as a low-priority issue. As a result, small
companies may be caught in a pay-for-performance disconnect, paying awards at the end of the year
without commensurate performance on important metrics.
To avoid this outcome, companies must manage their compensation programs proactively,
developing forward-looking compensation programs that focus employees on short- and long-term
performance. Part of this process requires directors to clearly communicate with large shareholders,
getting shareholder feedback well before directors outline compensation rationales in proxy
statements and hold ensuing SOP votes. This way, compensation committees will know what key
shareholders think of their proposed program revisions and how they will vote on SOP.
To achieve these goals, boards of small public companies must assure that:
Pay levels are benchmarked against the market by using a peer group of comparable firms
[2]
Susan Schroeder
judiciously chosen from a similar industry, size range, and
scope of work. This ensures pay competitiveness and guards
against perceptions of excessive pay. Care should be taken
to make certain that peer group companies are comparable.
Some large companies’ peer group selections have
encountered SOP opposition because they were not
particularly representative of the industry or within the
appropriate size range.
Incentive dollars are aligned with specific types of
desired performance. Grouping compensation dollars into
short- and long-term “buckets” helps the company
emphasize the most important time horizon and manage
overall compensation expense.
Annual cash bonuses are tied closely to specific
performance metrics, with narrow limits for discretion, if
any. A set range of payout pools (maximum and minimum)
helps manage cash flow and accounting concerns. In the
event that companies are short of cash in a given year, it is
advisable to build into bonus plans an escape hatch allowing
the substitution of equity of equal value or, if there are
dilution concerns, deferral of bonus payouts.
The right equity vehicle is used for long-term
incentives. For most small companies, the prevailing
vehicle for achieving shareholder alignment is stock options
because these companies tend to be growing rapidly. Stock
options provide the most leveraged incentive opportunity,
which is a great motivator for employees. Typically, stock
options vest over a three- to four-year period and have a
term to exercise of ten years.
A sufficient pool of equity is authorized for incentive awards. A framework and process
for granting equity awards is critical for small companies to ensure that equity is allocated
appropriately. Just because a company has this pool in place does not mean it must be drawn
from in years when performance is weak. Target ranges should be structured to account for
the possibility that there may be no equity awards in a given year if performance is especially
poor for reasons attributable to management.
Compensation programs are free of governance “lightning rods,” including tax
gross-ups, excessive perks and the absence of claw-back provisions. These items have drawn
critical fire at large companies, and can create shareholder-relations problems for small public
concerns, now that they are subject to SOP. Moreover, small companies should examine their
programs for any vestigial private-company practices that favor founding CEOs or outside
CEOs who achieve a founder-like status. These items may include arbitrary equity grants
and/or significant perquisites.
A common thread runs through all of these considerations: Is there a consistent rationale for each
element of the compensation program that shows it is generally focused on motivating performance?
Are there well-thought-out incentive plans? Is each feature of these plans proactive and aligned with
performance in ways that can enhance shareholder value? Can directors make the case for the
effectiveness of program elements in customary meetings with major shareholders?
If so, they both stand a good chance of enhancing performance, and will also have a better story to
tell shareholders in their proxy statements. As a result such companies will have a better shot at the
best SOP result, green-zone status and attendant optics that are highly positive.
Bertha Masuda and Susan Schroeder are partners in Vivient Consulting (www.vivient.com [3]), a Los
Angeles–based compensation consulting firm that serves compensation committees at public
companies, including small companies, by helping them develop effective incentive plans. Both were
formerly with Mercer Human Resource Consulting through its acquisition of SCA Consulting. Masuda
holds an M.B.A. from the Wharton School at the University of Pennsylvania. Schroeder has an M.B.A.
from UCLA’s Anderson School of Management.
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