The Advisors' Blog

– Mark Van Clieaf, MVC Associates International

Recently, we started using this “Board Dashboard” as a wake-up call to our clients. Our Dashboard provides an independent review of executive compensation based on these four “Fairness & Risk Tests”:

1. Defensible and business relevant peer group
2. Defensible job matching for compensation benchmarking
3. Pay-for-performance (including proper strategic performance metrics and risk horizons)
4. CEO and enterprise internal pay equity

Here is an anecdotal story about one client for whom we conducted a comprehensive executive compensation and incentive risk review:

Upon review, we found that:

– The company’s peer group was fine after we adjusted and removed outliers as compared to previous peer group used in the past – so we ranked “Green Light” on the Dashboard

– The job match for each role for compensation benchmarking also needed to be adjusted because it was a privately-held company with material ownership by one large shareholder who sat on the board. So that was fixed by benchmarking COO roles at other companies – a ” Green Light” on proper CEO job matching for benchmarking purposes. In the past, they had benchmarked CEO roles which led to ratcheting up the comparable CEO pay benchmarks.

– On pay-for-performance, the board was provided a cautionary “Yellow Flag” as the 3-year return on invested capital (ROIC) was in the second quartile and thus below median of the agreed business relevant peer group; yet CEO and executive pay was in the upper end of the third quartile (about 70th percent) – so clearly pay-for-performance alignment was out, but not at an extreme level. A LTIP re-design would fix much of the problem and move them into the “Green Flag” zone for next year.

– Internal pay equity was the big “Red Flag” for the board. Both the CEO role to the Named Executive Officers and the CEO role to the 3rd management layer down pay differentials which was over 8x (should have been 6x max). This suggested there was something wrong with the management structure and/or pay-delivery design.

The board asked us to look at the management enterprise structure and its internal pay equity from top to bottom. We put their data into our proprietary management structure analysis and internal pay equity database and the resulting output was fascinating. The company had 53% of manager-to-direct reports in the “Green” internal pay differential zone – the good news – as they fell within the optimal zone of 1.4 to 2.4x target range.

BUT the company had 24% of “manager-to-direct report” pay differentials less than 1.4x – a proxy indicator of a possible organizational jam up and overlayering and to everyone’s surprise, we identified 23% of manager-to-direct report pay differentials that were too big with over 150 managers who were identified on the Internal Pay Equity Differential report with large pay differentials of 6x, 10x and 20x+. These large differentials for 23% of managers are all in the Moody’s “Red Flag” risk zone of greater than 3x.

The board, CEO and HR head had no reporting systems to identify that they had 9+ layers of management (where only only 5 value-adding management layers are required) as well as the distribution of internal pay equity differentials which were far out of normal distribution.

So by reviewing the enterprise management structure and the internal pay equity and pay delivery review process, it was determined for this one client that:

– The CEO was overpaid by about 30%
– The Head of HR is overpaid by 2x-plus
– Overall enterprise compensation was excessive by 17% of the Total Cost of Enterprise Management (TCEM)

Now, the Board has asked for an offsite presentation regarding all the Red Flags and risks we found. Since the CEO is only 24 months from retirement, the board has set a plan to fix these management structure, over-layering and equitable pay delivery design problems and realize over $50 million+ of cashflow increase opportunity for shareholders upon CEO succession.