Reaching Consensus on Performance Measures
A significant part of our job as independent consultants is to help foster a healthy and highly effective working relationship between the compensation committee and executive management. To that end, we ensure that the committee receives the materials, analysis, and recommendations they need in a timely and efficient manner with the level of detail and background information that allows them to make fully informed decisions. Because of this, we frequently work with management at the direction of the committee to develop agendas and review materials in advance of committee meetings. The following example demonstrates how we’ve applied this thinking to actual client situations:
While advising the Compensation Committee of a large consumer products company, it became apparent over the course of our initial meetings that there were ongoing, unresolved disagreements among Committee members and between the Committee and Management regarding performance measurement. The Committee was concerned whether the company was using the correct measures and holding Management sufficiently accountable.
The discussion turned on earnings per share (EPS) and whether it was, indeed, the best measure of value creation for the Company. New members of the Committee favored an approach based on value drivers, using a combination of measures including cash flow, margins, and return on capital. Management had used EPS for many years and felt strongly that it was the best measure of share-based performance. The Committee Chair agreed with Management. Our basic view was that a value-driver approach was more financially sound, but our job was to help develop consensus and common ground rather than pursue our own opinions.
Realizing that these issues would not get fully resolved during the course of regular Committee meetings, we suggested that the Committee schedule a special one-time meeting to discuss the philosophical issues around performance management and to reach some level of common understanding. To prepare for the meeting, we interviewed the members of the Committee, the CEO, CFO, and senior HR leadership to understand their views. We also performed research and prepared reading material to help the participants prepare themselves for the meeting.
For the meeting itself, we facilitated a three hour discussion with the Committee, the CEO, and the vice president of HR to thoroughly discuss all points of view. This gave everyone a much more in-depth understanding, and the Committee came away with a greater appreciation of how EPS was the top level of a system of cascading performance measures woven throughout the organization.
At the same time, management agreed to the placement of restrictions on share buybacks that could be incorporated into the annual EPS calculation. The company continues to use EPS as the primary driver of pay and performance but with a greater understanding of how the measure supports the creation of value for the company.
