The NASPP Blog

The writing is on the wall; risk management through effective compensation practices is a hot topic right now. Recent regulatory developments and government initiatives indicate that all pubic companies may eventually need to explain to shareholders and investors how their compensation practices help align employee performance with shareholder interests and safeguard the company against excessive risk. I’m not just talking about your executive compensation, either. Now is the perfect time to take another look at your company’s equity compensation practices and decide if they are motivating employees to take reasonable risks that will help your company grow without encouraging excessive risk-taking behavior.

Shareholder Bill of Rights Act of 2009

This Senate Bill, introduced on May 19th of this year, would require companies to create a board committee to oversee company risk management. Specifically, it calls for companies’ risk management committees to be independent of their audit committees. While this bill does not call for publication of risk management in compensation practices, it does put a focus on the importance of managing risk.

Treasury Department Press Release

On June 10th of this year, Treasury Secretary Tim Geithner made a statement outlining the measures the Treasury Department will be promoting to help create financial stability. Among the focal points in this press release are several statements about how companies should be dealing with risk management. First, the Treasury encourages all company compensation committees to not only conduct, but also publish risk assessment of pay packages. Additionally, it calls for companies to ensure that compensation is structured in a way that fixes an appropriate time horizon for risks. To do this, the Treasury asks that companies provide their risk managers with the “appropriate tools and authority to improve their effectiveness at managing the complex relationship between incentives and risk-taking.”

SEC Proposed Regulation

On July 1 of this year, the SEC submitted its proposal on changes to compensation disclosures. In particular, this proposal includes requiring companies to discuss how they are managing risk-taking through compensation practices. The proposal doesn’t necessarily require this discussion for all companies; it is only required if the risks may have a “material effect” on the company.

Get Involved!

This trend of focusing on risk management encompasses your company’s broader compensation practices. It is important for your company to review its compensation practices (especially in light of the current economic situation) and stock plan administrators should be getting involved in what this will mean for equity compensation.

When it comes to managing risk, the most obvious way to tackle the issue is through performance-based incentives. Effective performance grants are good for everyone, and the economic conditions have made it clear that a review of performance metrics is warranted. Make sure that your stock plan team is involved in conversations on how to improve your performance metrics; not only to help make them more effective, but also to make sure you will be ready to administer the grants when they are awarded.

One of the most important points to make about performance grants is the need for a well-balanced mix of performance goals. When awarding performance grants to your executives and other key employees, using just a single metric (like share price or revenue) puts too much emphasis on just one target and potentially increases inappropriate risk taking by key employees. A good mix includes both short-term and long-term goals so that strong performance must be met and maintained. Even better, including both internal and external goals helps promote behavior that not only meets your company’s internal targets, but also keeps it competitive in the marketplace. For ideas on how to create effective performance-based compensation, check out our Performance Plans Portal.

Another great way to encourage sustained growth and effective risk taking is to put a long-term focus of at least a portion of equity compensation for your key employees. This can be done by requiring key employees to maintain a meaningful position in your company’s stock. What we’ve seen recently that has shareholders (and employees) in an uproar are executives who can leave the company and cash-out on huge equity compensation packages, but leave behind a company that is poised to fail because of ineffective risk management on the part of those executives. Companies are dealing with this by establishing hold-through-retirement policies, ownership guidelines, and claw-back or forfeiture provisions. Be sure to check with your risk manager, compensation committee, or head of compensation to see if any of these strategies are in store for your company’s equity compensation program.

Stay Informed!

Don’t miss out on the Executive Compensation session, “The Consultants and Counsel Speak on Say-On-Pay and Plan Design; Risk Assessment & Pay; and Hold-Through-Retirement, Clawbacks, and Litigation Issues, at our annual Conference this year. This fantastic panel of compensation experts are ready to equip you with all the latest on executive compensation best practices and necessary actions. Additionally, the 6th Annual Executive Compensation Conference (which is included with your NASPP Conference registration) includes the session “Risk Assessment and Executive Pay.”

Don’t forget, if you are not able to attend in person, you can listen in from your desk. The NASPP keynote address and the full Executive Compensation Conference will both be available live, and the entire NASPP Conference will be available on video archive. Sign up now, and take advantage of the 10% discount on the audio archive!

-Rachel