Craig Barbarosh is an experienced public company board member and law firm/business leader with over 25 years of professional experience. Barbarosh serves as an independent director on the boards of Nextgen Healthcare, Sabra Healthcare REIT and Aratana Therapeutics. At Nextgen, he is Chair of the Compensation Committee and has seen firsthand the impact ESG has had on executive compensation.
Barbarosh will be speaking at Corporate Board Member’s annual Building Better Boards: Committee Series event in Chicago on September 10-11. He caught up with Corporate Board Member to preview his session on the Compensation Committee program, “Balancing Act: Setting Pay for Performance Incentive Goals.” Below are excerpts from this conversation.
What are the biggest shifts you’ve seen in executive compensation as ESG continues to gain traction as a strategic imperative?
The biggest challenge in executive compensation is the most basic challenge – to align compensation with desired performance and to create a compensation structure that both rewards executives for short-term and long-term performance consistent with shareholder returns and corporate priorities and to incentivize and compensate for long-term performance consistent with strategic priorities. As
corporate strategies change over time, it is incumbent upon compensation committees to evolve compensation structures to consistently align with strategic priorities and financial achievements. This evolution can be challenging in the short-term as businesses grow and work through strategic challenges and corporate priorities evolve, particularly given the common reliance upon and associated pressure from designated peer groups in determining compensation. As compensation committees structure short-term (annual) cash bonus plans and long-term equity incentive plans, it is important to keep in mind that executive compensation should primarily be tied to alignment with shareholder returns. While shareholder returns are largely financial determined (typically based on profitability, operating performance and investor returns), in the current environment many institutional investors now view shareholder “returns” more broadly and while financial performance remains as the primary metric, ESG and other considerations that may not directly impact financial performance but can certainly influence TSR performance and underlying corporate culture are becoming more relevant to structuring executive compensation plans and are certainly becoming important topics of discussion among compensation committees.
What are the challenges boards are facing as they try to ensure pay for performance in non-financial metrics?
In general, most public companies are focusing more on performance-based equity compensation with reduced reliance upon time-based equity compensation. Performance is usually primarily determined by financial performance (revenue, EPS, operating metrics, etc.), but in the current environment of ESG and corresponding focus from institutional investors, performance can also be considered in the context of non-financial factors including success in instituting and executing upon ESG priorities. While most boards appreciate and focus upon the importance of ESG as a component of company culture, it is important to keep in mind that unless ESG can be tied to a specific and measurable corporate strategic objective, it is largely (but not exclusively) a cultural strategy which can necessarily be a contributor to drive or influence financial performance. Nevertheless, most corporate boards appreciate that positive corporate culture and best-practices typically support positive shareholder performance.
For many companies, ESG considerations are becoming more relevant in the overall performance discussion but many compensation committees are struggling to determine whether and how to implement ESG considerations in the context of executive incentive compensation plans. As a practical matter, in the current environment, when ESG metrics are utilized as a component of executive compensation plans, they are usually applied as a modest adjustment to the aggregate financial-based cash incentive formulas. If specific ESG action items can be attributed to the performance of specific executives and can be quantified and measured, they may be included in the compensation performance metrics for the individual executive or, as applicable, the executive team, but again usually only in modest allocations at this point. For example, the annual corporate objectives of the Chief Human Resources Officer might include specific and measurable ESG performance metrics (such as retention metrics, employee satisfaction scores, etc) with associated allocated compensation. For the CEO and CFO, however, ESG tends to be an underlying cultural driver that can have an impact on financial performance, but not necessarily a defined component of the specific incentive plan at present. However, as implementation of ESG evolves over the next few years I would not be surprised to see a specific ESG component incorporated into more CEO compensation metrics on the theory that ESG tone is set from the top, however these ESG “metrics” should be tied to some specific strategic goal of the company so that the ESG compensation component is aligned with the overall corporate strategic objectives. Certain industries, such as the energy and technology sectors, may create more opportunities for quantifiable and measurable ESG metrics. For example, an energy company may elect to assign a specific compensation metric to for the CEO and senior operating team for reduction of carbon emissions which can be tied to a corporate strategic objective of pollution abatement which is supports both ESG and general corporate goals. As a practical matter, determining the success of many ESG initiatives tends to be more subjective than objective, and it is important for compensation plans to be specific, measurable, relevant and quantifiable. For now, for the CEO and other senior executives, ESG issues may be most relevant for discussion in the annual performance evaluation and should be considered in the larger context of goals and achievements and relationships with other key constituents (including the board of directors).
What are some things you hope to discuss on the Compensation Committee program at Building Better Boards with your fellow directors?
As compensation committees structure short-term (annual) cash bonus plans and long-term equity compensation plans, it is important to keep in mind that executive compensation should primarily be tied to alignment with shareholder returns. While shareholder returns are largely financial determined, in the current environment many institutional investors view “returns” more broadly and while financial performance remains as the primary metric, ESG and other considerations that may not directly impact financial performance but can certainly influence TSR performance are becoming more relevant to structuring executive compensation plans and are certainly becoming important topics of discussion among compensation committees. I look forward to exploring these subjects with the other panelists during the Building Better Boards Compensation Committee program.