Non-Financial Metrics Are Making Their Way Into The Compensation Discussion

The days of the gap between board directors and company strategy are long gone, says R. Brad Oates, who currently serves as compensation committee chair at CIT.

“Lots of trends—including the scarcity of technical talent, cultural issues and many of the ethical scandals we’ve seen—are leading boards to be involved with strategy,” he says.

Oates will talk about these trends at Building Better Boards: Committee Series in Chicago on September 10-11 on the Compensation Committee track in a session titled, “Prioritizing the Talent and Culture Agenda.” Ahead of that session, Corporate Board Member caught up with Oates to talk about the ways boards are aligning culture with long-term business strategy and the influx of non-financial metrics into a CEO’s compensation.

Below are excerpts from this conversation.

What are some of the ways boards are aligning culture with long-term business strategy?

The obvious one is having conversations about things that typically [they have not had] conversations before about traditional governance structure. The traditional structure is noses in, fingers out. Independent board members should keep a wide birth from management. Very hierarchical. Shareholders elect directors. Directors elect CEOs. CEOs puts their team in place with the passive approval of the compensation committee. Board members stay away.

Lots of trends—including the scarcity of technical talent, cultural issues and many of the ethical scandals we’ve seen—are leading boards to be involved with strategy. And you can’t hardly talk about strategy without getting into talent because at the end of the day the platforms are so much less about tech than they are about talent. As we moved to knowledge-based business across the globe, this idea of talent, culture and strategy and getting it right, becomes paramount. Boards are getting pulled into those conversations. I think that you’re seeing deeper dives in boardrooms about all three of those things. I think that will continue to escalate. Boards will become more and more involved at a granular level to things that have historically been somewhat just the purview of management.

What kind of metrics should boards be administering on the CEO’s compensation?

Most CEO compensation, particularly at public companies, revolve around the basic structure of salary,  short-term incentives that are roughly maxed out at 150%…some will go up to 200% of salary…and then longer-term incentives will be 2x to 3x their short-term pay. And we’ve kind of gotten comfortable with that general structure. Some people will grant equity in different ways, which can be called different names, restricted units, performance units. It’s essentially the same thing. Equity that can vest and has drawback periods.

What’s starting to happen is in the incentive compensation, there are qualitative and quantitative outcomes. So, you’re starting to see things show up in the short-term incentives under the quantitative part. Typically, the quantitative part would be things like revenue and losses. Typical financial metrics. But we’re starting to see boards start to look at quantifiable diversity and other kinds of cultural outcomes. So cultural outcomes and more strategic outcomes that are non-financial are starting to be more prevalent in the short-term incentive. Long-term compensation is still pretty much tied to things like ROE and similar financial metrics. But at least at the short term we’re starting to see non-financial metrics make way into the quantitative. I would say non-financial outcome metrics are starting to make their way into the compensation discussion.

Join R. Brad Oates at Building Better Boards in Chicago on September 10-11. Register here.

What are you excited to talk about at Building Better Boards?

I want to know what are the problems that boards are wrestling with? What are the real practical problems? I want to learn. I want to listen more. I want to understand what are the problems and what are some of the solutions that people are thinking about. With ESG, it’s a bigger part of governance but I will tell you it’s not yet for certain that investors who speak about ESG will accept lower returns for longer-term ESG outcomes. I think we’re waiting to be shown what it can do. It sounds good, but we haven’t had enough history of the trade off in the economic return [for that kind of deal]. Index investors, the big institutional investors, are talking a great game. But I think the truth will eventually be whether or not they’re really willing to make those tradeoffs. And whether the companies themselves can tell the investors what tradeoffs have really been made. We have yet to play that out in boardrooms.