Blog: Is it time for a reimagined compensation committee?

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Perhaps during the shutdown, when you’re watching more TV than you might like to admit, you’ve seen some new commercials a bit like this: a happy face-masked employee on the line or in a lab displaying all the sanitizing and other pandemic-related safety precautions that the company is taking to protect the employee’s work environment. Cut to the employee at home with giggling youngsters, illustrating the importance of safety measures at work to protect family at home.  Or a company emphasizing the value of its employees in keeping the country moving forward or its employees in lab coats that persevere to find a cure no matter what.   Or a shot of employees performing the essential service of implementing safety measures for customers.   What’s the point? To drive home that a company that recognizes the value of its employees and manifests such concern for their safety and welfare is a company worth buying from.   This new emphasis on employee welfare as a corporate selling point may have been sparked by COVID-19 but, at another level, it may well reflect broader concerns that have been marinating for a while—about the essential value of previously overlooked elements of the workforce, about physical risk allocation, about economic inequity and,  to some extent, even about social justice.

How to address some of these concerns related to the workforce—particularly economic inequity—is the subject of a new paper co-authored by former Delaware Chief Justice Leo Strine, “Toward Fair Gainsharing and a Quality Workplace for Employees: How a Reconceived Compensation Committee Might Help Make Corporations More Responsible Employers and Restore Faith in American Capitalism.”  The goal is to reimagine the compensation committee so that it becomes the board committee  “most deeply engaged in all aspects of the company’s relationship with its workforce,” from retaining and motivating the workforce to achieve the company’s business objectives, to overseeing that the company fulfills its obligations as a responsible employer and, most of all, to positioning the company to “restore fair gainsharing.”

The authors open with a discussion of the growing recognition of prevailing economic inequity: “top executive pay and stockholder returns have soared as company profits have risen, but the pay for ordinary workers has stagnated,” a trend that has led to pressure on boards for change and corporate accountability. “A company, they write, “cannot be a good corporate citizen without being fair to the stakeholders most important to its success, its employees.”  They suggest that a “reconceived compensation committee” might be one way to help boards “sensibly address society’s demand” for fair pay and fair treatment for the workforce.

How did we get here?  The three decades after World War II witnessed a remarkable growth in middle class wealth, as economic gains of the expanding market economy  were widely shared.  During that period, workers were able to exert more power over companies, in part, the authors suggest, because investors, largely retail, tended to be more dispersed and more passive than today’s institutional holders.  During that period,  as worker productivity and corporate profits increased, companies shared the profits

“between their workers (in the form of pay raises and other forms of compensation, including retirement and health benefits) and stockholders (in the form of higher dividends and other forms of payouts)….From 1948 to 1979, worker productivity grew by 108.1% and wages grew in rough tandem by 93.2%.15 That is, as workers’ productivity enhanced the value of the corporate enterprise, they shared in the benefits of those productivity gains. Top executives were much better paid than the typical worker, but at a ratio that was merely substantial, not astronomical. For example, the CEO-to-worker pay ratio was 20-to-1 in 1965.”

In addition, the S&P 500 rose 554% from 1948 to 1979.

However, beginning in the 1980s, the authors assert, as “labor unions waned in influence, powerful institutional investors reaggregated equity capital and began to exert enormous pressure on public companies to be responsive to their desires for immediate returns.”  They used that power, according to the authors, to demand that executives “be paid in ways that encouraged them to be an instrument of the stock market, even if that hurt the company’s other constituencies, including workers.” Think, for example, stock options and performance metrics based on TSR. The authors observe that, from

“1979 to 2018, worker productivity rose by 69.6%, but the wealth created by these productivity gains went predominately to executives and stockholders, with worker pay rising by only 11.6% during this period, while CEO compensation grew by 940%. In terms of the split between the average worker and stockholders, the movement was even more profound: stockholders began taking a huge slice of the pie, with the S&P 500 gaining over 2,400% from 1979 to 2018.”

In response to these striking disparities in pay and the impact they have had on our social fabric, the authors contend, “new strains of corporate governance reform emerged.” These strains are reflected in, for example, Elizabeth Warren’s Accountable Capitalism Act (see this PubCo post) and the recent adoption by the Business Roundtable of a new Statement on the Purpose of a Corporation, signed by 181 well-known, high-powered CEOs, which “moves away from shareholder primacy” as a guiding principle and outlines in its place a “modern standard for corporate responsibility” that makes a commitment to all stakeholders, including employees. (See this PubCo post.)

What’s more, the authors contend, after years of advocating pay for performance for executives, where performance is based on TSR or other stock-based metrics, even institutional investors are now advocating that companies recognize their obligation to benefit all stakeholders, including communities and employees.  This view is reflected in the new Business Roundtable statement of purpose (although, notably, the Council of Institutional Investors opposed the Statement, contending that it “gives CEOs cover to dodge shareholder oversight”). Similarly, Laurence Fink, the CEO of BlackRock, has made a number of statements advocating corporations’ broader social responsibilities.  (See this PubCo post.)

In addition, adverse publicity arising out of “high-profile situations”  has led to concerns about workplaces that tolerate, or even foster, sexual harassment or racial or sex discrimination.

The authors also point to a new “business reality”—the recognition of the value of human capital in a tech-driven economy. (Notably, the authors balk at the term “human capital,” viewing it as “reductive and demeaning.” Sign me up.)   This recognition has led executives to appreciate the benefit of a skilled and productive workforce that is capable of learning new skills.  They also observe that the emergency caused by “the COVID-19 pandemic is likely to make issues related to the fair treatment and economic security of American workers even more salient.”

As a result of these trends, the authors expect that boards will be called on “to dedicate more time to considering how their companies treat their entire workforce, how inclusive their workforce is, the appropriate incentive systems that should exist not just for top management, but the whole employee complement, and the appropriate gainsharing that should exist among the company’s employees, stockholders, and top management.”

The authors contend that, to address these issues, “the most sensible answer is for the mandated board committee that is required to address the related area of top management compensation—the compensation committee—to expand its perspective and become a committee focused on the company’s workforce as a whole.” Reimagining the committee will require that the board gain some understanding of the historical context of “gainsharing” among executives, workers and shareholders over time. The committee will need to arrive at a fair balance that “will best align the interests of all stakeholders in sustainable wealth creation, and develop compensation plans for the board that implement that goal.”  The authors contend that understanding this broader context will help boards “constrain top management pay in sensible ways”:

“If, for example, the company’s workforce is getting no raise, does it really make sense to give top management an increase for “managing through tough times”? And if the company is doing well after a period of employee sacrifice, are their raises keeping up with gains for stockholders and the CEO? Does the company have a goal of paying its CEO and top management at or above the 75th percentile on the industry average? If so, does this goal extend to all company management? To all company employees? Or just to top management? If the latter, why? If the board has a better sense of how the entire workforce is compensated, and the importance of the workforce to the company’s plan for selling products and services, the board is also better positioned to understand what will have the most important effect on productivity. Is it increases to top executive compensation? Or increases that motivate a much greater number of company employees?… Perhaps it is just the magic four or five at the top who really have a bottom line impact, or perhaps, and much more likely, the overall workforce’s productivity is more vital to the company’s profitability, and that providing all the company’s workers with quality pay and the opportunity for continuous training, employment, and advancement makes good business sense.”

In addition, the variety of legal requirements, together with the growing sustainability focus on the workforce, make it logical to allocate these responsibilities to the comp committee.

The essay includes suggestions for specific data regarding worker and contractor pay information—along with key employee and contractor function, educational level and skill set—that should be provided to the committee to allow the committee to understand how the company deploys its workforce and how it relates to management’s business strategy.  The authors suggest that the committee consider questions such as the following:

  • What are the employee functions most critical to the company’s ongoing vitality?
  • And how is the company treating workers that are essential to its operations?
  • What are turnover rates?
  • What is the extent of retraining of existing workers to master new skills?
  • What is management’s process for setting employee compensation?
  • To what extent does the company bargain with workers or give them any leverage?
  • What is the company’s view regarding its employees’ right to form a union? If opposed, how does that harmonize with the company’s ESG commitments to workers and with its treatment of executives?
  • Does the company pay equally for equal work, regardless of gender, race or ethnicity? Does it promote equally? Is the workplace welcoming and inclusive?
  • Are employees treated with respect and dignity (perhaps by reference to surveys or other behavior monitors)?
  • Do the data provided by management reflect productivity and effectiveness of company practices?
  • Is the board using metrics and factors for determining executive comp (e.g., use of a 75th percentile goal) and not applying the same metrics to company employees?
  • Is executive comp “tilted toward the stock price and risk taking,” thus potentially undercutting the company’s commitment to sustainability? Is the salesforce incentivized to sell customers “things they do not need”?
  • Does the company’s compensation system appropriately recognize the importance of ethics and compliance executives or “hold them down in pay because they do not run ‘profit centers’”?

The role of the committee is this inquiry will help establish that the “tone at the top on fair treatment of employees, openness or hostility to unions, and the atmosphere in the workplace in terms of diversity and freedom from harassment emanates from a board-level decision, and that management must adhere to that decision in its treatment of employees at all levels of the organization.” In addition, the authors contend that these types of questions “will assure a top to bottom coherence and yield valuable insights into the company’s business strategy and its actual adherence to rhetoric about its regard for its workforce…. Of most salience to society, by means of this kind, the board will be better situated to analyze the basic question of gainsharing among employees, top management, and stockholders [the authors] view as fundamental and to make more enlightened decisions.”

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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