As CEO incentive pay packages bring attention to transparency issues in executive compensation, a group of directors and chief risk officers from The Directors and Chief Risk Officers Group published a set of guiding principles for compensation committees around the governance of risk related to pay and performance.
The report aims to give a company's board of directors and board-level compensation committees guidelines for the governance of risks linked to an organization's compensation culture.
Here are 10 guidelines for compensation committees to best guide executive pay and performance, according to the report.
1. Compensation committees must fulfill both direct and indirect pay governance responsibilities to define the best compensation culture for the company. Under direct governance responsibilities, CEOs must establish and continually review company-wide compensation philosophy. To fulfill indirect pay governance responsibilities, a company's executives must ensure adequate resources and processes are in place for the organization's incentive plans.
2. Committees should emphasize incentive pay for corporate performance when designing and communicating the company's compensation philosophy. Incentive pay for an individual's performance must be carefully applied when it is appropriate to fulfilling the individual's role.
3. A CEO's total compensation should be driven by how they impact the long-term interests of the company, which includes how effectively the organization takes risk.
4. A company should minimize use of external benchmarking, or the comparison of its statistical data with other organizations in the same industry, for executive pay. Instead, companies should work to incorporate internally-focused pay evaluation for executive pay.
5. Incentive-based compensation should always be considered to be "at risk," subject to deferral periods and influenced by the company's long-term performance.
6. Compensation committees must continually use discretion in determining an executive's final incentive pay package. In this way, committees must make rules for determining these pay packages subject to discretionary override when the compensation culture of the organization appears to be violated.
7. When considering performance reviews and compensation design for an organization's CEO and individuals in the succession plan, the compensation committee must provide complete transparency to the entire board. This includes the board's approval of full details of the CEO's performance and any final awards given to the executive.
8. Compensation committees should obtain public certification that ensures their processes of governing pay risk and compensation philosophy are "fit for purpose," which entails executing a statement that verifies a company has performed due diligence on its pay governance processes.
9. The members of a company's compensation committee should have diverse backgrounds and experience, expertise in risk, finance, and management and should cross-populate the company's risk and audit committees.
10. To ensure proper compensation risk governance, companies must incorporate collaboration, feedback and review among board committee's and the firm's social network to maintain a properly established compensation culture.