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L&A Original Article: L&A’s Response to HBR’s “Decoding CEO Pay”

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There was an article titled “Decoding CEO Pay” recently published in Harvard Business Review, and in our opinion here at Longnecker & Associates, Messrs. Pozen and Kothari have some valid points, and many that are not so valid. It appears they found a few unique, obscure examples and turned them into this “bad compensation practices” article, and we would like to respond by providing our valuable expertise on these important issues to our readers.

Based on our experience over the years in the boardroom, their potentially valid points seem to be:

1. Yes, companies could do a better job disclosing incentive metrics and tying to standardized reporting that investors typically review.

2. Yes, companies and their advisors could be more thoughtful on compensation peer company selection, specifically regarding compensation and relative TSR performance.

3. Yes, ISS and Glass Lewis both have their flaws.

However, their far-reaching points seem to be:

1. Companies utilize adjusted earnings measures to derive something that is much closer to true operating profit (i.e. EBITDAX). This makes better sense from an incentive plan design. The caution is if there are several extraordinary items that occurred and are stripped out of the equation resulting in above target bonus, but the shareholder bore the brunt of those extraordinary items via stock price.

2. TSR peer companies are not cherry picked. Most of the time, companies utilize an objective group of companies either through an index or investor-centric companies. These are always established well ahead of the performance period. Many companies also include a mechanism to prevent payouts when absolute stock price drops significantly. Lastly, most of the payout schedules for these relative TSR plans drop off significantly below median performance and combined with the lackluster stock price, which results in appropriate shareholder alignment.

3. Revenue and market cap are not the only measures to determine size, complexity and performance to derive strong compensation peer groups. Balance sheet health, EBITDA, growth patterns, asset location, and several other factors are important to identify fair compensation peer groups.

4. Following European compensation and governance practices, such as developing a compensation best practice and compliance association, may not be in the best interest of US companies because:

a. We currently have Say on Pay, and the 2017 results are 92% approval, while only 1.4% of the Russell 3,000 actually failed Say on Pay; and
b. The US has long dominated any list measuring the top-performing 100 global companies.

In conclusion, the Harvard Business article was written to show “bad compensation practices” but failed to look at the other side of the coin, and in return missed the majority of companies that are following “good compensation practices.”