Executive remuneration programs are under unprecedented scrutiny. Never before has there been such extensive government intervention in the executive pay arena. The pressure to justify compensation practices is not limited to the financial services industry. Governmental and regulatory bodies around the world have proposed or enacted changes that would affect not only the governance of executive remuneration, but also the substance of pay programs at all public companies. Changes that are already taking place, including voluntary or mandatory adoption of “say on pay,” which lets shareholders vote on how companies pay their top executives, speak to the increased influence of shareholders.

Companies that cannot demonstrate alignment between performance outcomes and executive remuneration programs or that have not adequately explained this relationship to shareholders risk not only severe reputational damage, but economic losses as well. We believe that an important part of risk management is ensuring that executive remuneration programs are responsible, defensible and commensurate with sustainable performance.

Transforming executive remuneration to drive performance

Mercer has compiled “10 for 2010,” a list of 10 action items that companies should take this year to enhance the prospects of success in 2010. By “success,” we mean designing an executive remuneration program that drives business performance, secures key talent and withstands public scrutiny.

Use “10 for 2010” to initiate discussions and help formulate your executive remuneration agenda for the remainder of the year.

1. Audit your program to ensure pay for results.

• Assess whether the overall philosophy and each element of your executive remuneration program support delivery of responsible executive remuneration.
• Consider the defensibility of each program attribute in the context of business objectives, cost and shareholder requirements.

2. Ensure that the vehicles, mix and eligibility of the long-term incentive program are appropriate.

• Assess whether the characteristics of each vehicle and its weighting align with your objectives for the program, including managing share usage, and with employees’ perceptions of vehicle effectiveness. 

3. Ensure program balance by examining multiple dimensions.

• Performance metrics: Cover the range of relevant dimensions of performance – growth, profitability, returns, shareholder experience and nonfinancial metrics.
  
  
• Target setting: Incorporate a wide range of internal and external perspectives into the target-setting process.
  • Measurement approach: Assess the mix of corporate, business and individual performance in determining award outcomes; consider the appropriateness of absolute and relative measures.
  • Vehicle selection: Use a blend of cash and equity remuneration, and consider a mix of vehicles when granting annual and long-term incentive awards.
  • Time horizon: Use a balance of short-term (one year), intermediateterm (two to four years) and long-term (five years or longer) remuneration elements, taking into account your business cycles; consider the time horizon for equity holding requirements.

4. Assess the risk that payouts do not reflect sustained performance.

• Ensure that inappropriate risk taking is not driven by incentive plans.
• Red flags include:
  • Emphasis on short-term performance at the expense of long-term performance
  • Overreliance on highly leveraged equity vehicles or plan payout curves
  • One-dimensional or redundant performance measurement
  • Rewards for performance that is not sustainable
  • Failure to stress-test plans for outcomes under extreme scenarios
  • Failure to tie the compensation time horizon to the business cycle
  • Failure to have appropriate equity holding requirements

5. Look for “hot button” issues.

• These issues include:
  • Severance and change in control
  • Perquisites
  • Tax gross-ups
  • Supplemental retirement benefits
  • Clawbacks

6. Address limitations of market data.

• Recognize the limitations of data for this volatile year, and reduce reliance on market data when making executive pay decisions. Identify the multiple perspectives that may be right for your company:
  • Compensation as a percentage of profits or shareholder returns
  • Tally sheet of wealth accumulation
  • Internal equity of pay outcomes
  • Directional alignment of pay with performance 

7. Plan to do a deep dive into 2009 results before payouts are made.

• Evaluate performance against targets and on a holistic basis at the conclusion of the year.
  • Regardless of performance against targets, validate whether the payout is warranted.
  • Examine the disclosure implications of payouts.
  • Revisit measure selection, the target-setting process and calibration of pay for 2010 based on 2009 results.

8. Conduct executive talent assessment.

• Identify your key contributors, who may be different in this new landscape.
• Ensure that rewards actions are aligned so that key contributors’ compensation reflects their value.

9. Verify that your remuneration committee governance reflects best practices.

• Governance expectations are changing rapidly and may even be driven by pending governmental and regulatory proposals. Therefore, it is important to:
  • Revisit the committee agenda and calendar for the balance of the year to ensure that key topics have been adequately addressed.
  • Keep your remuneration committee apprised of market and regulatory developments.

10. Prepare for “say on pay” if you are not already working under it. 

•  “Say on pay” could become a reality in more countries around the world in 2010. Start now to manage your risk of a poor voting outcome:
  • Do action items 1 – 9, above.
  • More than ever, assess your current disclosure and consider how compensation actions made in 2009 will be disclosed.
  • Engage the remuneration committee.
  • Plan a shareholder engagement strategy.