In particular, executive compensation policies should contain, at a minimum, the following components:
1. The company’s desired mix of base, bonus and long-term incentive compensation This section should include adequate detail to shareowners regarding the company’s philosophy of base pay components versus “pay at risk” components of the program. Details should include reasonable ranges based on total compensation within which the company will target base salary as well as other components of total compensation. Overall targets of total compensation should also be provided.
This section should also provide an overview of how the company intends to structure the compensation program, such as how much of overall compensation is based on peer relative analysis and how much of it is based on other criteria. The policy should clearly articulate how the company ensures optimal alignment of interests with shareowners through the design and implementation of its executive compensation program.
2. The company’s intended forms of incentive and bonus compensation, including what types of measures, will be used to drive incentive compensation. In addition to the relative mix of base salary and any form of incentive compensation, the company should provide a breakdown of the types of incentive compensation and reasonable ranges based on total compensation targets for each type of incentive compensation within the program.
The policy should include the company’s philosophy related to the major components of incentive compensation, including the strengths and weaknesses of each and how the overall incentive component of the plan provides optimal alignment of interests with shareowners.
CalPERS believes that in the case of option plans and restricted stock, a significant portion of the overall program should consist of performance-based plans. These include index-based options, premium-priced options and performance targets tied to company- specific metrics.
Performance-based plans should be constructed to reward true out-performance, and should include provisions by which options will not vest if hurdles are not obtained. Time-accelerated vesting is not considered a meaningful performance-based hurdle.
The policy should include the specific drivers the company will use in constructing the performance-based components of the plan. CalPERS suggests using metrics such as Return on Invested Capital (ROIC), Return on Assets (ROA), and Return on Equity (ROE), and the relative mix of how performance metrics will be weighted.CalPERS believes that optimal plan design will utilize multiple performance metrics in a fashion that will tie small portions of vesting to individual metrics or larger portions of vesting to multiple metrics.
CalPERS believes that if metrics are used in combination, the plan should require that each component be satisfied to achieve vesting as opposed to one of several that must be achieved.
3. The company’s intended distribution of equity-based compensation.The policy should include the company’s philosophy related to how equity-based compensation will be distributed within various levels of the company.
In the event that the company uses equity-based tools in its compensation program, the policy should articulate how the company will address the issue of dilution. For example, the company should provide a detailed plan with each option program addressing the intended life of the plan and the yearly run rate.
If the company intends to repurchase equity in response to the issue of dilution, the plan should clearly articulate how the repurchase decision is made in relation to other capital allocation alternatives. Calipers does not favorably view repurchase plans that are
4. The company’s philosophy relating to the dilution of existing equity owners simply targeted to mitigate and obfuscate dilution caused by stock option plans.
5. The parameters by which the company will use severance packages, if at all.
6. The parameters by which the company will utilize “other” forms of compensation, if at all.
The policy should provide broad guidelines by which the company will use alternative forms of compensation, and the relative weight in relation to overall compensation if “other” forms of compensation will be utilized.
The term and length for “other” forms of compensation should be disclosed. Other forms of compensation include but are not limited to pension benefits, deferred pay, perquisites and loans. In some cases, other forms of compensation can provide significant value to executives, which are not readily comparable to more basic forms of compensation such as salary, bonus and incentive.
Other forms of compensation are also more likely to be perceived by shareowners as not providing meaningful alignment of interests or incentive value. To the degree that the company will provide other forms of compensation, it should clearly articulate its philosophy for utilizing these tools with specific treatment of how shareowners should expect to realize value from including these forms of compensation Executive compensation programs should be designed and implemented to ensure alignment of interest of management with the long-term interest of shareowners. Executive compensation should be comprised of a combination of cash and equity-based compensation. Direct ownership should be strongly encouraged.