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Compensation: Some guiding principles.

How to craft a sensibly designed and well-implemented executive pay program.

IN JUNE OF 1960, I joined the salary administration department of 3M Co. (it was then called Minnesota Mining and Manufacturing). This was my first position in the corporate world. Salary administration was certainly new to me, and executive compensation was a deep mystery which was beyond my understanding. However, early on in my new position, it was obvious that executives were on a different compensation track than other salaried people.

Since those early career days, I have always believed that there were some guiding principles which could be set forth concerning sensibly designed and well-implemented executive compensation programs. The following principles have evolved from being on "both sides of the table" as a corporate practitioner and more recently as a compensation consultant. These principles certainly should not be viewed as absolutes. Instead, they are considerations which can be used in the development of an effective compensation program for a company's executives.

The executive compensation program must fit the culture and meet the specific needs of the individual organization. This principle, I believe, is paramount. It recognizes the "given" that there are no two organizations which have the same cultures and needs. Some companies have cultural similarities. Also, many organizations have like needs in the structuring of their executive compensation programs. However, individual variations exist and must be reckoned with if the program is to meet the organization's compensation objectives. Therefore, at the very start of the program's development, the designers, be they company executives or consultants, must have a clear understanding of the organization's culture and its specific needs. The process takes time. If this meaningful analysis is not made, the program is prone to failure.

With this overarching principle as our backdrop, here are 10 additional principles, not prioritized in any particular order as they are all believed to be of equal importance.

* Determine how the three major components of the program -- base salary, annual incentives, and long-term incentives (includes stock options) -- fit together and the emphasis that should be placed on each. Many call this evaluation the company's executive compensation strategy. It is an essential evaluation which must be made at the very beginning of the program's development. It is imperative that management expresses its views as to how each component is expected to be used and the weighting for each.

* Beware of the external data trap. Many compensation practitioners have too much of a love affair with external data. They firmly believe that the data very much dictate the program's design. Use the data as it should be used as part of the required analysis. Realize that it is only one part of the decision-making process. The program's design must be the right one for the organization and not necessarily right for the data sample.

* Get necessary input from the involved staff groups. Some executive compensation designers look at the structuring of a program as a very private exercise in which they alone should be participating. You are asking for real trouble if you do not solicit the input of the organization's involved staff groups such as tax, legal, and finance. These staff groups must be involved in the process. The designing of executive compensation programs requires the sharing of the expertise of many individuals from a wide array of internal professional sources.

* Keep the design simple and understandable. This principle is becoming more and more obvious today, but on many occasions, it seems to be forgotten. To me, the design of an executive compensation program is much like that of developing a new airplane. In both cases, the designer should not be the only person who can run the compensation program or fly the airplane. If such is the case, the program will fail and the airplane can be expected to crash. The design of the executive compensation program must have features and workings that are understandable to top management, the compensation committee, the participants, and those who will be charged with its administration.

* Beware of approach favoritism. All of us -- board members, compensation professionals, and consultants -- have favorite approaches in the structuring of executive compensation programs. Much of this approach favoritism is based on past positive experiences in other business settings. It is difficult for most of us to accept the fact that an approach used so successfully in a past situation may not work in the current situation. For instance, the granting of currently popular restricted stock may not be appropriate in many business situations today.

* Realize that the executive compensation program is not the cause for many of the companies' problems. Most senior executives and board members seem to agree with this principle. However, when conditions get difficult and a "star performer" decides to leave, many times an immediate and strong focus is put on the executive compensation program. Critics of the existing program blame it for everything, including its lack of being able to retain "stars" to not motivating the executive workforce. Without a doubt, in some situations the allegations may be well founded. However, care must be taken in identifying the real underlying problem. Money is not always the solution. Use it prudently.

* Clearly define the population to be included in the program and keep it "pure." In many ways, current business practices are becoming more unstructured. I believe this trend can be very positive as long as we do not reach a point where essential defined practices are eliminated. The same reasoning holds true for the development of an executive compensation program. It is essential that criteria are developed which clearly define the people who will be included in the program. The defined population should include line and staff managers and also individual contributors who play an active and recognized role in making the business successful. If you have an individual who does not meet the program's membership criteria but warrants monetary recognition by the making of long-term incentive or annual incentive awards, give a special nonrecurring grant. By taking this action, the membership criteria for the executive compensation program is kept "pure" and certainly future problems can be avoided.

* Keep the compensation committee informed. It is of prime importance that the compensation committee is kept informed as to the structuring and performance of the executive compensation program. Based on my experience, most directors do not want to be overwhelmed with extensive details, but they do want to know on a continuing basis if the program is successful or if it is falling short and therefore may need some "renovation."

* The successful implementation/communication process is key. Many individuals who are involved in the development of an executive compensation program emphasize the design phase of the program over how it is implemented and communicated. If the program is not implemented and communicated effectively, its chance for success is very limited. Since it requires a particular focus on the structure and details of the program, the implementation/communication process unfortunately is viewed by some as being dull and offering few challenges. But I do believe that some meaningful steps can be taken during the communication stage which will help make the program more "real" to the participants. Here are a few for consideration:

--Conduct more small group meetings rather than large meetings for program participants. Usually participants feel more comfortable in asking questions with fewer people around than in an auditorium full of people.

-- Stay away from lengthy printed pieces describing the program. Executives will not read them. If you want to describe the program, craft a concise outline featuring its highlights (stay away from the details!).

-- Finally, give the participants the opportunity to value the components of the program by making projections on their personal computers. In today's high-tech world, this can be done by offering tailored software programs.

* The current design of the compensation program is not forever. When I got started in the executive compensation business, cash compensation was the major element of an individual's base salary. Today, long-term incentive plans dominate the scene. Companies have favored stock options, but with the recent downturn in the market, other long-term incentive instruments in the future may be emphasized. All of this means that your current executive compensation program is not fixed in design and should be under periodic review as to meeting the expected changing needs of the organization.

As a final thought, all of us who are involved in the development of executive compensation programs take appropriate pride in the results of our efforts. This is fine, but we should not permit our pride of ownership from keeping us from developing a more improved and useful product -- within the framework of the guiding principles as set forth above.

Fred Meuter Jr. has far over 40 years worked with boards and management of a wide range of clients--from Fortune 100 to mid-size and smaller organizations -- in developing and implementing executive compensation programs. He founded his Fountain Hills, Ariz.-based consulting practice, Fred Meuter Jr. & Associates, in 1988 after serving for 16 years as manager of executive compensation for Xerox Corp. A sought-after speaker on compensation subjects, he has been program director for the Conference Board's annual compensation conference and executive compensation seminars for the past 12 years.

Role(s) of the compensation committee

Ed. Note: Fred Meuter Jr. has authored several important articles for DIRECTORS & BOARDS over the years, including "The Performance Unit Unleashing Its Power at the Operating Level" [Summer 1986] and "Questions the New Compensation Committee Member Should Ask" [Winter 1989]. The classic nature of the advice that this expert of some 40 years in the Compensation field brings to his writings can be seen in the following excerpt from his article "The Pragmatic Calling of the Compensation Committee," published in our Spring 1987 edition.

To accomplish what I like to call their "pragmatic" charter, the members of the compensation committee must individually and collectively take on certain roles:

* Defender -- not just of the shareholder's interests but also of the remainder of the company employees who may not participate in a plan which is being approved. Are their interests being hurt by this action? Is there some degree of internal equity being maintained? Are overall good business ethics and practices being followed?

* Initiator -- of new/modified actions and plans. The initiator mode can be activated by Committee members' reactions to data proposals being presented; to the questions they ask management and the replies they get; and to the statements made by management.

* Reviewer -- of plans and actions presented by management. Directors furnish another opinion; their past experience can be useful.

* Designer -- I call this the "suppressed creative designer urge" which so many committee members have. Maybe it has been caused by their dealings with the professional consulting community. This is a role that many directors play very effectively, and now is their chance to use it. They do have biases, it is true, but they also are a resource which can be tapped as one moves through a plan design phase.

* Implementor -- by its approval of plans and particular actions, the committee acts as an implementor.

* Supporter -- a key to the overall role of the committee. It can give collective support for actions being considered by management. In particular, it can reinforce the actions that the CEO is considering taking or has taken in the compensation and other personnel areas.

* Counselor -- very close to its role as a supporter. Who can the CEO talk to? Who can be used to try on management's succession plans? Who can the CEO use as a "ventilator?" This is a real role for the committee and its members and one which can be expected to grow in the future.

* Critic -- The committee member and the committee as a whole should be a positive critic, one which furnishes an intellectually honest second opinion.

One could conclude that the committee's charter and its members' roles could be completely open-ended. This is not true. There are certain activities that the committee should avoid:

-- Reviewing reams of data;

-- Responding to technical questions;

-- Deciding on particular actions concerning a large group of individuals;

-- Resolving differences in proposed compensation approaches; and

-- Becoming a "lid" on well-thought-out and useful compensation plans! strategies.

Most of all, the committee and its members should not make decisions which really should be made by top management. There is a fine line of distinction between the CEO using the committee as a "sounding board" and it becoming another required level of decision-making authority.

Fred Meuter Jr.
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Publication:Directors & Boards
Geographic Code:1USA
Date:Mar 22, 2001
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