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The evolution of overarching executive compensation principles

Governance Advisory Services |Executive Compensation
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By Don Delves | February 16, 2018

Guidelines are important for any profession including the field of executive compensation. A set of Overarching Principles helps executive compensation professionals assist companies to articulate purpose and strategy and align these findings with meaningful compensation and incentive programs.

Toward this end, over a period of years, we interviewed and held round table discussions with several hundred board members of public and private companies to discuss executive compensation. We were interested in the challenges they faced in governing executive compensation, what the key problems were and how best to address them.

While these directors were almost universally opposed to any kind of rules or regulations for executive pay, we heard strong support for a principles-based approach. They sought powerful but simple principles that could provide them guidance, orientation and direction, but still allow significant flexibility and business judgment.

To develop these principles, we convened a core group of directors and used a research process called the Delphi Method to identify, develop, define and then narrow a list of principles. This method systematically asks experts a series of questions, provides anonymous results and encourages participants to reconsider their initial answers, thus narrowing the group’s responses and moving toward a targeted answer. Developing a short list of principles that collectively captures the significant, and often conflicting, list of objectives boards are trying to accomplish simultaneously when governing executive compensation became our objective.

The resulting principles, which we refer to as the Overarching Principles, are as follows:

Purpose: An organization’s senior management team should ultimately be focused on achieving the stated purpose of the organization, and executive compensation plays a significant role in reinforcing this orientation. Purpose centers on why the company exists, and, in our definition, also includes its mission, vision, values, strategy and objectives. For purposes of executive compensation, it encompasses the highest level of abstraction, representing the broadest concepts that a particular company has defined and articulated. Coupled with the other principles, it clarifies alignment, accountability and engagement.

Alignment: Appropriately aligning the interests of management with the interests of owners represents a core concept of executive compensation. This fundamental tenet, agency theory, has driven much of executive compensation design and governance for decades. Executive compensation should foster and reinforce alignment with an organization’s purpose, mission, values and strategy, and with the creation of long-term shareholder value. The board and executive compensation professionals need to understand the owners’ interests and make sure they are accurately reflected in the design and governance of executive compensation programs. Focus, direction and objectives throughout the organization are also folded into the concept of alignment.

Accountability: Accountability is key to the efficient functioning of any organization. And compensation, incentives and performance management are the primary tools by which most organizations establish objectives and hold people accountable to achieving them – including the CEO and senior executive team. This principle includes core functions of executive pay including performance measurement, goal setting and performance assessment for the organization and individuals.

Engagement:  Executive compensation should help an organization provide significant motivation, clarity of direction, commonality of interest and delineation of responsibilities and priorities. Pay programs should be competitive, have clear goals and a “line-of-sight,” be well communicated and easily understood, and have a clear tie between performance and payouts.

A convenient shorthand

We believe that these four Overarching Principles capture, in broad strokes, the significant majority of functions and governance of executive pay. They provide a convenient shorthand and conceptual framework for discussing, assessing and making decisions about executive pay.

However, other principles such as sustainability, responsibility and affordability may be important and needed for some organizations and situations. They will be discussed in a future blog post. You can also learn more on our Willis Towers Watson Guiding Principles web page.

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