Considering leading practices: a panel of experts explores current practices in executive compensation.

Executive compensation remains a hotly-debated issue, garnering the attention of boards of directors and, certainly, compensation committees. This subject was one of four that were researched and discussed at the third annual Changing the Game Forum of The Center for Corporate Change, a division of the Vail Leadership Institute.

Attendees gathered again in Beaver Creek, Colo., in early June, this time to focus on leading practices in four key areas: board practices for setting the tone and culture of the firm; ethical leadership development and succession planning; practices in executive compensation and practices in multi-stakeholder performance valuation and reporting. The executive compensation session is summarized.

Randy Jayne, managing partner with executive search firm Heidrick & Struggles, interpreted the results of a survey of the proxy statements of some 75 Fortune 500 companies, reviewing their executive compensation practices. He first established a three-factor values framework with which to assess the practices: appropriateness, fairness and effectiveness.

A key finding from the work, said Jayne, is that "pay-for-performance has been embraced by 100 percent of our sample group as the guiding philosophy for executive compensation."

He also noted that these companies utilize three common strategies for implementing the pay-for-performance philosophy. They weight a small group of focused performance metrics to reflect the unique role of different executives; adjust compensation to reflect the relative performance of a company in its peer group in the marketplace; and link performance priorities with the unique cycle-time considerations of a company.

Jayne identified two areas where additional progress can be made. First, most companies fail to disclose actual "scorekeeping" of year-end bonus calculations, thus camouflaging or lending suspicion to the appropriateness and fairness of incentive payments. Also missing from most company proxy statements, he said, is a discussion of severance plans for named executives. An exception to this is how severance is treated when there is a change in control.

The Panel Discussion

Ellen Heffes, managing editor for Financial Executive, moderated the panel consisting of one compensation committee chair and two compensation consultants. She compared concern about executive compensation to a volcano, since it is always brewing under the surface, until its fury erupts. "In times of glowing economic news," she said, it might get little or limited attention. "But should the economy hit a bump--or a bubble--the subject erupts and becomes front and center." With huge payoffs making headlines, Heffes asked the panel about the "public perception" of packages, and what are companies doing right?

Edward Graskamp, managing director of Fredrick W. Cook & Co., said a sea change is occurring for compensation committees, not only in terms of rules, regulations and standards, but also in terms of public expectations. He suggested nine building blocks of effective compensation: committee independence; charter and clarity of roles; committee support; clear statement of philosophy; internal and external fairness; appropriate external benchmarking; linkage of pay to performance; focus on long-term value for shareholders; and communications transparency and clarity.

James F. Reda, managing director of James F. Reda & Associates LLC, suggested that a company's compensation philosophy should have four components: peer group specifics; pay positioning strategy (target percentile); internal and external equity; and alignment with the company's business plan. He noted that there is not a close tie between a CEO's evaluation and compensation except for short-term bonuses, and that a typical pay package consists of 20 percent bonuses, 15 percent salary and 65 percent LTIP (long-term incentive pay).

A third panelist, Gen. John T. Chain, retired from the U.S. Air Force, is chairman of the Thomas Group and director of Kemper Insurance Cos., Reynolds American Inc., ConAgra Foods Inc. and Northrop Grumman Inc., where he chairs the compensation committee. Chain said that even if the CEO's compensation is high, it represents a very small percentage of the total management group compensation, and that "you get what you pay for." The people that a committee is most interested in are already CEOs, he said, and the "really good ones are hard to find and harder to move."

Chain recommended that an executive be paid a base salary below the median of the peer group and have all incentives based on performance. This latter component will be the principal wealth-creating mechanism for the executive. The big issue, according to Chain, is how the CEO's compensation compares to his or her peers. He said it is very hard to look at peer group data and not give that compensation to the company's executives.

Daniel J. Sweeney, a founder of the Center for Corporate Change and a trustee of the Vail Leadership Institute (www.vailleadership.org), also serves on the Board of Directors of West Marine Products Inc.