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The Employee Ownership Report

NewsletterConcisely written for leaders in employee ownership companies and for service providers in the field, the NCEO's bimonthly newsletter, the Employee Ownership Report, is the most efficient way to stay informed about legal issues, current events, best practices, breaking research, management approaches, and communications ideas for employee ownership companies.

Available exclusively to NCEO members, the Employee Ownership Report is delivered in hard copy and all issues back to 1997 are available in the members-only area of the Web site.

Nonmembers are invited to read the sample article below from the current issue of the newsletter. Every time a new issue appears, the sample article on this page will be replaced by one from the new issue. Join online for only $90 to receive the Employee Ownership Report and all our other membership benefits.

Read a sample issue of the entire newsletter (September-October 2015).

Sample Article from the March-April 2019 Issue:

What Should an ESOP Board Compensation Committee Do?

Fifty-seven percent of ESOP company boards have a compensation committee, increasingly made up in part or entirely by outside directors. What should these committees be doing to make sure compensation is handled appropriately? The Importance of Outsiders Having outsiders on the committee (and ideally constituting a majority of its members) is important for many reasons. It provides more credibility to the trustee and the employees that executive compensation is being handled responsibly. It can help defuse sometimes contentious issues over compensation between officers. It can bring useful outside expertise and perspectives into the process. While it is not a requirement of ERISA to have this process, it is clearly a best practice.

The recent NCEO survey on ESOP company governance shows that 23% of companies have compensation committees that are composed just of outside directors, 27% have insiders and outsiders with an outsider chair, and 13% have both insiders and outsiders with an insider chair. Thirty-seven percent have only insiders on their compensation committees.

Whose Pay to Consider

Corporate bylaws generally require that boards at least set pay for the top executive officer, and many compensation committees focus only on that, while many others will set and/ or approve recommendations on the pay of other top executives. Beyond the top executives, committees may make recommendations on the general approach to the mix of fixed and incentive pay for all employees. A committee might make recommendations on the specifics of a company's bonus or profit sharing system, but normally these will only be be recommendations; outside board members rarely have the depth of expertise about the company's labor markets or personnel issues to make final decisions.

Whatever pay issues are covered, committees generally will act on the recommendations of the CEO on pay at whatever levels the committee is involved with, but in larger companies or companies where committee members have compensation expertise the committee may control the process from the start. There is no "right" way to do this. What works will be a function of the skills of the people involved and the governance culture of the company.

Pay Issues to Consider

The level of pay is obviously a critical issue, but compensation committees also need to consider the form. How much will be fixed versus incentive pay? Should incentive pay be in the form of equity grants or an annual bonus (or both)? If it is an equity grant, what kind of grant makes the most sense? How often should grants be awarded and how often should they be redeemed? What triggers an incentive award? Profits? Sales? Meeting some specific goal for the year? A combination? Should there always be a formula or should the CEO have discretion for awards to other executives? These are not easy issues to decide.

Metrics to Use

The goal of compensation is to pay enough and pay in the right form to attract, retain, and motivate people. Turnover and employee surveys can provide input on these issues. From a hard-nosed economic perspective, paying anything more to attract, retain, and motivate people is just a gift. In addition, executive pay must be fiduciarily sound, as explained in the last section of this article.

There are three common approaches to help decide if compensation achieves these goals. The first and most obvious (and maybe most common) is just to do what you have always done. If it is working, there needs to be a compelling reason for change.

The second is internal equity. The theory here is the pay levels of each succeeding level in the company should reflect the incremental value added by that level. So supervisors should make x% more than those they supervise, managers x% more than supervisors, etc., all the way up to the CEO. That can set the level of pay that is reasonable, although not the form.

The third is survey data. The NCEO publishes data on executive compensation in ESOP companies; many trade groups have surveys for their industries; and large-scale surveys, such as CompData, provide data across industries. Surveys can be useful, but use them with caution. Most do not include contributions to retirement plans, but ESOP companies may make significantly larger than normal contributions to retirement plans when the ESOP is included. Surveys also rarely count synthetic equity grants, such as stock appreciation rights, that are common in ESOPs. Surveys also tend to have an upward bias—companies participating in them often pay more and are looking to justify their pay levels. Troubled companies, by contrast, rarely participate. So treat surveys as a reality check for being within a band of reasonableness, not a guide to what you should pay.

Fiduciary Issues

Finally, committees need to know their fiduciary duties. Boards have a responsibility to make sure executive pay is not a waste of corporate assets. That is a broad term that can encompass wide ranges of pay. It is subject to the largely permissive business judgment rule. Trustees, as shareholders, could challenge boards on this issue, but only two cases have ever made it to court specifically on executive compensation, and the facts in each were such that they don't provide much guidance. While legal exposure is limited, in ESOP companies committees and boards should take their responsibility seriously.