Adapting executive pay strategies in uncertain times

Speaker A: Foreign.

Speaker B: Hi, everyone, and welcome to the new Shape of Work podcast. My name is Gord Frost, and I'm the global reward solution leader at Mercer. For those of you who are regular listeners, you'll know that for this year, I've been sharing the hosting duties with my colleague, Kate Bravery. Uh, for those of you who missed the sounds of her voice this month, don't worry, she'll be back to host the next podcast in the series. But for this month, I'm really pleased to be joined by two colleagues to join, uh, key issues in executive compensation and reward. So, David Thiky is based in Dallas. He's our executive reward leader for the US And Canada. And Peter Boreham is based in London, and he's our executive reward leader for Europe. Gentlemen, welcome to the podcast today.

Speaker A: Thanks, Gord.

Speaker C: Thanks, Gud. Good to be here.

Speaker B: All right, so. So, uh, guys, maybe the first thing is there's so much economic uncertainty and volatility that we're seeing in the markets today. How do you see companies adopting or adapting their executive rewards plans to the rapidly evolving business climate? David, why don't I start with you?

Speaker A: Yeah. Thanks, Gord. What we're seeing is a number of companies consciously or subconsciously dusting off their Covid Playbooks and using many of the key tenants that were employed, uh, during the pandemic a few years ago. Um, and these strategies really center around a few key pillars, including maintaining flexibility. Uh, they're not necessarily rushing to do things as the markets and news keep shifting every day. And, um, they're using the remaining time during the performance period to really monitor developments and ensuring that all the facts are understood, especially with the lack of certainty around many key, uh, topics, including their supply chain, uh, or other impacts to their business. And then we're also seeing some assess their metric target setting. So maybe looking to do things like wider ranges around target, uh, looking formally at things like permitted exclusions and formalizing the treatment of those exclusions to avoid potential adverse accounting and disclosure ramifications. So those are really Gord, from the US and Canada side, where we see companies, uh, starting to, or where they are with respect to their thinking in this dynamic environment.

Speaker C: It is a bit less flexible, I'd say, for European listed companies, at least for their disclosed executives. Um, any discretion that's to the benefit of the CEO. Uh, and the management team is typically treated with a degree of suspicion by investors and proxy advisors. So there needs to be quite a strong business case and ideally really a track record of both positive and negative discretion. Below the disclosed executive population, though, it's pretty similar to what you're describing, David. There's a lot more freedom to act. I'd also say that this whole issue about unpredictability, um, and volatility feels like the new normal. You know, we've obviously had the COVID pandemic, we had the Russian invasion of Ukraine. We've got the current geopolitical uncertainty. It almost feels like the new normal. And I think some committees and boards are uh, almost looking at a long term de risking of the package, particularly in Europe where generally rewards have been more volatile in terms of year on year changes.

Speaker B: Yeah, that's a really interesting point. And you know, we are starting to see some of that reflected in the way these compensation programs are disclosed and structured and communicated to shareholders. So Peter, I'm wondering, are you seeing any highlights of this or any evidence of this in the recent disclosure that's been issued for the most recent year?

Speaker C: Yeah, I mean it's been a pretty benign AGM season in Europe. We've not seen huge scandals. There have been a couple of companies that have had significant votes against on the basis of Quantum, but generally it's been pretty good. And I think one of the positive things is that the proxy advisor box ticking. While it's still a problem, it's getting better. We're seeing a bit more case by case from the proxy advisors and also from the investors. And the investors are saying, well, does this organization really compete globally for talent? Talent and therefore does it need to have a more flexible approach to pay? And do we as an investor actually trust the board to make judgments on the pay of the CEO? Uh, and do we believe in the capability of the CEO? Uh, in which case, yeah, we'll give you a pass. Of course, if those conditions don't apply, they may come to a different conclusion.

Speaker B: Yeah, interesting. David, what are you seeing?

Speaker A: Yeah, I would agree. In the US and Canada, it's also been a fairly quiet proxy season, uh, this spring. Uh, what we do continue to see though is that companies and investors, um, placing increased value and waiting on telling their compensation story in, uh, the compensation discussion and analysis. So much like Peter was mentioning, the successful disclosures that we see are often centered around as much about the how and why with respect to the executive payment levels and program designs as it is the quantum of how much the executives are paid. Obviously there are some outliers there much m like there are in Europe, but that's in general what we're seeing.

Speaker B: Yeah. And you know, I think that becomes Even more important in an environment of uncertainty where you might have to make some changes over the course of the year or potentially use discretion, obviously then, you know, building that trust, as Peter referenced earlier, that external advisors have in the board to make those kinds of, those, those kinds of judgments is all based on how well you communicate, why you've done it, how you've done that, how that aligns with the business circumstances and the interest of shareholders. At the end of the day it's

Speaker C: an evolution, isn't it? I think it's from disclosure, uh, to communication. What are we doing, why we do it, what is the reason that this is actually shareholder in your interest. And that's a positive, right? I mean we all read compensation disclosures for a living. They're pretty dull and at least in the, and the UK they're very patent. But actually this is the opportunity for the board to tell its story.

Speaker B: Yeah, well, and um, and um, to take that a step further, you know, it's also the opportunity I think for them to really rethink like are there some more innovative practices that we should be leveraging as we think about our compensation design for executives so not just following the same pattern that we might have followed for the rest of uh, for the, for the last several years or the same pattern that we see within our peer group or within the industry. Have you seen any innovative practices, Peter, that you think are really interesting to note, particularly for some global organizations?

Speaker C: Yeah, I mean I'm quite encouraged by the fact we are seeing a bit more flexibility. I mean there was a bit of a dark period where it felt like pretty much every board was using the same cookie cutter. Whether this was a volatile company or a stable company or it had a very long term investment cycle or very immediate payoff, it looked like the pay was always the same. That seems to be changing and particularly we're seeing organizations be a bit more thoughtful about long term incentive. You know, is this a highly leveraged play because we've got a fantastic growth opportunity. I was talking to a client a couple of hours ago where that's exactly their context. Or actually are uh, we extremely cyclical and therefore we need to do something that looks very different. I mean one of my very cyclical commodities client actually abolished the annual bonus for their CEO and they're just making very large awards of performance. Granted stock which replaces both the STI and the LTI wouldn't be suitable for most organizations, but it fits with their particular context.

Speaker B: Yeah, interesting. David, what are you seeing?

Speaker A: Yeah, I would agree with Peter, those general themes are also prevalent in the US And Canada. And I get this question sometimes about what makes the program innovative. And, and I think many people lean in towards innovative means it has the most bells and whistles or the shiniest object in the room. But sometimes, uh, what it means is that, uh, it could be streamlined and really targeted. And I think that's where we're seeing companies go, um, and really make sure that whatever metrics they put in or the designs that they put in fit their situation and fit the purpose that they're designed for. Much like Peter was describing. You know, I think historically there was more of this follow the herd type approach in the US where companies would just bolt on this metric because it was the most prevalent in the market or their closest competitor added it to their program. And what that risks is diluting the overall program and the messaging and, uh, the focus around what is really important here. So I think sometimes looking at it from an innovative way, uh, it may be counterintuitive, but what we're seeing is some of the best, uh, programs are those that are more simple and streamlined.

Speaker B: Yeah, it's interesting. It reminds me of a conversation I had with another organization just recently where they were saying the plan has evolved over time. There's been multiple iterations. They've made changes and made additions and changed performance metrics. And now this may not again sound innovative, but they said, we're at the point now that we want to just take a step back and ask, is this truly aligned to our business priorities? Is this driving the right behaviors at the end of the day? Um, and do our executives actually understand how the plan works? And their concern is that the answer to those questions is currently no or they don't know the answer. Right. So I think bringing it back to basics, even though that may not sound so innovative, I think is actually important to remember it's not innovation for the sake of innovation. It's actually really bringing it back to what's the purpose of the plan? How does it align to our business strategy? How does it align executives to shareholder interests? And do they actually understand how all of those things link together? Um, one of the things that I think is a challenge with that just sort of pivoting for a minute. And Peter, I'd love your opinion on this. First, is that's especially difficult in organizations that need to manage sort of the dynamics between a global organization with regional operations in different parts of the world and differing kind of local country practices. So with the multinationals that you work with, how do they kind of, you know, align those maybe diverging dots or kind of bring that all together?

Speaker A: Yeah. And maybe. Gord, I'll kick this one off. Um, you know, since from the US we're typically looking at things as being kind of the highest common denominator or the highest payer, uh issues often arise around, you know, how do we, should we pay globally or under one scale or should we pay locally, you know, in each of the companies that we operate. And that's in particular with respect to incentive levels. And if you drill down even further, it's with respect to long term incentive levels. Where in the US it's been, uh, you know, widely known that we have the highest long term incentive levels in the world. Um, for large multinationals, what we see is that a common approach is there's a level in the organization where effectively a figurative line is drawn and everybody above the line, which would include executives, is on the global and the US pay structure. And just given the presence of the executives in the US most of the time and the transferability of these executives potentially across roles and geographies. And for those that fall that come in above the line, uh, many US comp multinational companies just accept that those executives in non US locations will be paid hyper competitively versus a truly local based executive or local based talent, um, below the executive level. A number in the multinationals have established tiers or buckets or categories especially for things, uh, uh, especially for LTI grants. And it's usually expressed as a percentage of the US grant level. So for example, maybe this group of countries in Western Europe would be 80% of the US grant level. And what these do is that it allows for pay levels to be more closely aligned when the local country practices. But in speaking with a number of clients they, they do admit that it can result in still the US multinational being hyper competitive on a truly local basis. But that is just something that uh, US multinationals just live with and can often be a value proposition when they do set up operations here. Um, you know, roles that are truly local and meaning that they will not and cannot be sourced outside of a, of small area or the country. Uh, some multinationals will take a localized approach, but again the balance here, uh, going back to, you know, our prior conversation around, um, streamlining and not being overly complicated, the balance here is, uh, is it worth the administrative effort to set up effectively a whole new pay structure in a country where maybe the headcount is not as uh, large as would warrant something like that. So um, again that's just the general approach for it. I mean, there's variations, uh, beyond this, but, uh, that's how we see many large US multinationals address this concept.

Speaker B: Yeah, interesting. Peter, I'd love your perspective. Kind of from the other side of the world. Right. In that if the US companies end up being hyper competitive, the European company can't be under competitive. Right. So how does a European company kind of approach those, those same kind of challenges?

Speaker C: Yeah, I mean, I think, I think there are some cultural factors in play, you know, and it also comes down sometimes to the strength of a brand in a particular market. But typically, you know, European multinationals, the starting point will be European pay. And they will pay like European companies in most sectors. They'll then pay more to people in the US typically by having higher incentive percentages for those US based executives. Um, we have seen some interest in what David talked about, which is having a sort of cadre of people who are basically paid like Americans. There are some difficulties with that. I mean, as David said, at some point you move into the top hundred. When you move from position 101 to position 100, suddenly there's a huge discontinuity in pay. And of course it's more expensive. Um, where the US is a bigger influence is in these really globalized sectors, things like oil and gas, pharmaceuticals, technology, where European companies will tend to pay at a sort of mid Atlantic level. But if they're listed companies, then of course their disclosed executives are ah, subject to say on pay voting. And they can't go about giving, you know, 1,000% salary target LTI, because they'll just lose their say on pay vote, which means that that's held down, which then creates compression below. So typically pay is just a little bit lower in Europe, but then the social context is very different in Europe and I think sometimes this gets forgotten about. I remind the European clients I work with, look, you know, university education, post retirement healthcare, these things are cheap or free in Europe. They're very much not cheap or free in the United States. The pension provision is better in Europe, both on the social side and on the company side. And holidays are longer, you know, so, you know, everybody wants a situation where they have kind of French holidays and Swedish pensions and um, you know, US LTI and Norwegian base salaries. But that's not the real world, is it? You have to make a choice.

Speaker B: Yeah, and I think there's a lot. So good.

Speaker C: So one final thing though, where I've seen this go a bit wrong is where European companies decide that they'll aim for US Pay level with a European pay mix that tends to lead you to a place where your base salaries in the US are absolutely insane. So your fixed costs are too high, um, and you can't fire people. And it's just the wrong approach for most companies. I saw one of my clients last year where they were paying somebody in the US a base salary that was two and a half times what they were paying somebody in Germany. And that doesn't feel like the right answer. If the LTI is higher, do something with lti.

Speaker B: Yeah, no, I think those are all really good points. And I think this discussion just really emphasizes the importance of, first of all, having a really solid compensation philosophy, uh, that aligns back to your business strategy, your values, all of that kind of stuff. Understanding who really is your market for talent and who you compete with. You mentioned some markets, Peter, like oil and gas or energy or pharmaceutical, where there is much more of a global market for talent. And so the competitive dynamic is different. And then in other industries, that may not be the case. So I do think that thinking through all of these elements in a really careful way and thinking about it holistically, I thought you brought up a really good point of it's not even just base salary, annual bonus, lti. Right. Thinking about the broader context of where do your executives live and work, what's the cost of retirement? What are the other costs of, you know, living that they incur? You know, does that impact your decision making? I think those are all, you know, very, very good points. Um, I'd love to get your points also, or your thoughts, Peter. Also on, are you seeing increased flexibility, um, from investors in the way that CEOs are paid? Because you talked about the fact that, you know, the institutional investors and others in the investor community are quite, you know, have a quite set point of view. And I'd like your view on is that changing or evolving?

Speaker C: Yeah, I mean, in Europe, for the last, really since the global financial crisis, we've had a bit of a straitjacket on compensation. And we have these binding votes on compensation policy, where every four years in the eu, three years in the uk, you get the policy approved, and once that's approved, you cannot go outside it without shareholder approval. So, you know, and that held down executive compensation probably a bit too much in terms of level, but it also led to a kind of cookie cutter where certain things weren't allowed. And some of the things that weren't allowed always felt a bit arbitrary to me. There wasn't always a Lot of logic to it. But there was a bit of a change really in late 2023, um, investors, regulators, other stakeholders started to fret about public markets in the US being much healthier than public market the uk in the eu, things like the IPO of arm, a um, long term nurse, a client, uh, but it was re IPO'd in the US having previously been listed in London, being headquartered in the uk, being incorporated in the uk. I think that really focused minds. Now of course businesses like ARM list um in the US for a variety of reasons and I wouldn't say that CEO or director compensation were anywhere near the top of the list. Nevertheless, for dynamic high growth companies in things like uh, tech and life sciences, there's a lot to be said for having that greater flexibility in the US now. Since then M, we have seen some companies initially in the UK primarily get a bit more flexibility for the investors. They've gone along and said look, we are competing globally for talent. We are in a globalized sector, uh, we have significant US operations, we'd like to do this thing. Will you support us? And actually we've seen quite strong support where there's been a business case and where the board has gone out and socialized what it's planning to do with investors and proxy advisors. Um, some of the degrees of freedom just would have been unthinkable two or three years ago. So I feel quite optimistic about that. It's been slower in the rest of Europe than the uk but I know that boards in continental Europe are looking there again, particularly in sectors like life sciences, tech, energy, where the US is a very significant influence.

Speaker B: Interesting.

Speaker A: Yeah. And Gord, I would just build on that. You know, from the US perspective, as Peter mentioned, you could argue that we had the most flexibility. Just if you think of us as the highest common denominator, we only have that advisory vote on say on pay, which is still important, but it's not as binding or it won't put the straight jacket on you necessarily like the binding votes uh, in UK and Europe will. But we have seen uh, you know, with some of our Canadian uh, organizations given their proximity to the US then becoming more attuned to practices and pay levels in the us uh and saying listen, our talent can basically drive across the border. So uh, if we're going to go out and try to recruit that or be competitive in this global talent market, uh, we do need to maybe be a little bit more flexible and you'll start seeing that as play out. And as some of the larger Canadian Publicly traded organizations have added U.S. companies to their peer group, despite what the proxy advisors may say, uh, or think about that. So I think we are seeing this kind of maybe opening up, uh, a little bit in Canada, um, to looking at being more flexible and realizing that the US Market is a viable one for their executive market of talent.

Speaker B: Yeah, yeah, no, and look, I think it makes perfect sense. And again, it comes back to the discussion of, like, what is your market for talent? Who do you compete with for talent, you know, where, where do you source people from or potentially lose people to? And that does have to drive a lot of that decision making. And, um, ultimately, to me, there's a couple of things that I would take away. I think, first of all, the fact that you do need to understand your business context. You need to understand what's important for your business and aligns to your business objectives. But then again, you need to understand, you know, different organizations are active in different parts of the world, have different stakeholders, you know, have different relationships that are important to manage. And that ultimately, I think ensuring that you're getting good advice, whether it's from, you know, um, a legal opinion, you know, internal legal counsel or external legal counsel, you know, including that ensuring that there's a number of stakeholders around the table that are contributing to these decisions is really important at the end of the day. Um, and then maybe if we could just end on kind of one other topic that I think is top of mind. Everybody's talking about AI these days. I think AI weaves its way into all of our podcasts in one way or another. And so one of the questions that I've received recently, and I'd love both of your opinions on this, is what happens in an executive situation where, you know, AI is impacting the business, leaders are making decisions around, you know, potentially workforce changes as a result of automation or as a result of AI changing the way that work gets done, potentially that could impact jobs and could result in potentially some job losses. Um, but that ultimately then the company potentially could have productivity improvements or become more profitable as a result. And then at the end of the day, executives get paid bonuses. Right? And you can't necessarily draw a direct line between the executive was paid a bonus while laying off this group of workers. But I think a lot of external stakeholders do make that direct connection. Um, and I wonder what your perspectives are or how you think that would be seen in the different markets that you primarily work in. So maybe, David, I'd love to start with you and then switch to Peter to Close us off there.

Speaker A: Yeah. So I think this AI and its impact on organizations is still to some degree on the bleeding edge. We've seen some impacts, but I don't think we really understand all of the impacts right now. So I think as it relates to the concepts you're talking about is as this trend evolves, I think everybody is going in that or most people are going in that direction. Um, the messaging and the change management around the dynamic you describe will be something that will be very key. Because to your point, Gord, if something looks like ah, headcount reduction is triggered by AI to drive payouts, a very kind of simplistic point to point connection, uh, it's probably going to bring some unwanted scrutiny. And so I think companies, or you're going to see companies look towards leaning in on concepts like business improvement and value creation versus looking at it as, quote, you know, just a cost cutting measure at the end of the day, but certainly something that companies are going to have to, you know, deal with as if this AI trend, AI trend continues to play out.

Speaker B: Yeah. Peter, your thoughts on that?

Speaker C: Yeah, I mean attitudes towards this I think is slightly different in Europe to the us. Um, historically investors have tended to react quite badly where there have been significant layoffs at the same time as big bonus payments to executives. There was a French company that got into trouble for this a couple of years ago. Um, and I think there's an expectation that companies need to think about their wider social responsibilities, not just about their short term costs. But look, I think I agree with you, David. We're at the bleeding edge with all this. We're not exactly sure where this is going to end. And um, yeah, I suspect any predictions we make at this point, uh, are going to um, prove to be wrong ultimately.

Speaker B: Yeah, I mean none of us has a crystal ball, right? And especially in today's environment with so much volatility and so much change. Certainly AI is part of that, but it's just one of the main factors that's impacting organizations right now. Um, maybe just some closing thoughts right in the world that we're living through today, um, are there any things that organizations might not have thought of because they haven't lived through this volatility so recently, or maybe if it's new and different. Are there any things that you think we should leave as a kind of parting gift to our listeners today of things to be think thoughtful of through the balance of the year? Peter, maybe I'll start with you and then we'll just finish off with David,

Speaker C: it feels to me like organizations should just be thinking about the robustness of their incentives. How are they going to behave in a much wider set of circumstances than they normally think about? How robust are we to those extreme situations? And that could be extreme on the upside as well as extreme on the downside. I'll be comfortable with how this is going to pay out what's in the toolkit to moderate those things. If in fact we think we need to moderate. And just a focus as well I think on does that apply differently at different levels? I think the extreme volatility and payout for top executives linked to performance is fine, but when you get down to that N minus 2, 3, 4 level, um, I'm not sure that extreme volatility is necessarily appropriate because it's probably down to good or bad luck rather than the decisions that you've taken.

Speaker A: Yeah.

Speaker B: Dave, any thoughts, Any thoughts you have?

Speaker A: Yeah, I would say there's, there's generally two. I agree with what Peter said. I think bringing the remuneration committee or compensation committees along with the journey here and getting their buy in on potentially what are inclusions or exclusions at the end of the day will be good things. Um, like tariffs, you know, certainly haven't played out if they hold to what has been kind of the headline percentages, they haven't played out at those levels before. So really making sure that everyone's informed to make that judgment call if there is one needed at the end of the day, uh, will be important. And then the second one, we've um, seen the market, stock market, that is be very resilient in the face of some of this volatility, at least from the US perspective. But there are probably some organizations that will or have been impacted. And just as a, a thought here is just around, uh, ensuring that your share pool under your equity plan has sufficient reserve in case the stock price were to take a decline. Most companies go out and get these approved at their annual meeting. So it's a, basically once a year shot and just understanding what the capacity or dry powder is there and making sure you go early enough to not have to need a special meeting or worst case you run out of shares to grant. Um, because the market volatility does introduce some headwinds uh, to your stock price. So um, those were two things that I think companies should just be thinking about uh, in these times, uh, as they move forward.

Speaker B: Yeah, thank you. No, I think those are great, great thoughts. And the one I would just add to the list for our listeners is some of the clients that I'm working with, they're doing a lot more scenario analysis, right? So they're thinking about if the markets goes in this direction, if the market goes in that direction, if this happens, if that happens, they're doing more scenario planning and then communicating the outcome of that to their remuneration committee or their HR committee of the board so that all the stakeholders are well aware of the potential outcomes of different courses of action and where decision may be needed and things like that. So all really good advice. Um, so look, with that I think we've had a great discussion today. I want to thank both Peter Boreham and David Fiki for joining me. I want to thank all of our listeners for joining as well to the new Shape of Work podcast. Um, you can find us on all of your favorite podcast channels and look for us uh, next month as well. Thanks everyone. Have a great day.

Speaker C: Sam.