Directors’ Duty: How to Increase Compensation Transparency?

Transparency is the new buzz word in corporate governance. The concept of corporate transparency has long been applied to public company executive compensation. But what about private company executive compensation? Compensation program details in private companies are often not fully shared with or misunderstood by directors and shareholders.

What is the private company board’s responsibility to understand and communicate the compensation policies and practices to stakeholders (including shareholders, employees, and the broader community)?

Corporate governance influencers like Larry Fink, chair and CEO of BlackRock, advocate for directors to assume deeper involvement with the company’s long-term strategy and exercise leadership on a broad range of issues of interest to stakeholders. He applies this concept to public, private, and nonprofit organizations across industry sectors, not just those in which BlackRock holds a position. In Fink’s famous annual letters to CEOs, he reminds boards of their fiduciary duties, specifically transparency and disclosure to stakeholders. The letters prompt questions about public disclosure of corporate activities, including executive compensation.

What is the right balance of information that should be provided by the board? What are the pros and cons of giving this information? These issues are worthy of board discussion, and results will vary based on specific circumstances for each company. 

Seven Questions for Directors

Given the many external factors prompting companies to be held accountable for their compensation practices, private company disclosure of compensation is beginning to shift from an option to an expectation. In fact, many private companies strive to adopt best-practice governance processes. However, this new expectation presents challenges for private company boards; specifically, knowing where to begin and what key elements to focus on.

We have compiled seven questions for directors to ask to understand and ascertain the main tenants of the compensation program to communicate. 

1. What is the company’s compensation philosophy in regard to defining the market and pay positioning relative to such market?

2. How do the designs of the annual and long-term incentive plans compare to those of other privately held companies?

3. Is the mix of fixed (salary) vs. “at-risk” (bonus or LTIP) compensation optimal?

4. How do the compensation programs align with achieving company goals and driving shareholder value?

5. In what ways do the compensation programs achieve pay for performance?

6. What is the appropriate value creation sharing percentage between shareholders and management?

7. How are the compensation programs most appropriately communicated to the various stakeholder groups?

Boards can set the tone for open communication on these issues by clearly explaining the compensation programs and facilitating stakeholder feedback. On the other hand, failure to communicate on compensation topics could create mistrust among stakeholders. This is especially true in current times, where stakeholders are calling for increased disclosure on many private company business practices. As we’ve seen, environmental, social, and governance has become a hot topic in the world of disclosure, with stakeholders looking for sound rationale and sustainable business practices. The same transparency is desired for compensation data, as most recently seen in the newly enacted California law on pay equity reporting. 

The Trend Continues

California’s new law (Senate Bill 973) requires employers, both public and private with greater than 100 employees, to file equal pay reports annually starting in March 2021. This report includes the number of employees by race, ethnicity, and sex in various job categories—from executives to service workers. W-2 income data will be reported by tallying the number of employees in each job category and categorizing their pay in pay bands as established by the Bureau of Labor Statistics. This law is flawed as it requires an overly broad aggregation of dissimilar jobs into artificial pay groupings and does not consider whether the employees perform substantially similar work. While the data to be reported and analyzed will not likely be very meaningful given the flaws, this new pay report will emphasize pay equity in private companies, and boards should be prepared for this heightened scrutiny.

As private companies adopt new strategies to meet the desire for more transparency in the workplace, thoughtful communications around pay transparency must be a priority for boards. Begin by addressing the seven key questions and providing substantive context and rationale behind compensation decisions. These practices will increase stakeholder engagement, improve employee motivation, and ultimately lead to stakeholder trust and business success.

Bertha Masuda is a partner at Compensation Advisory Partners.

Susan Schroeder is a partner in the Los Angeles office of Compensation Advisory Partners. She is a 2022 NACD Directorship 100 honoree.