Extraction et création de valeur

OCP Partner Karel Leeflang writes on how focus on both current and future value can boost innovation and growth.

Published in L'Agefi on 26 February 2015.

Click here to download the PDF

Quieting the Pay-for-Performance Critics

Quieting the Pay-for-Performance Critics

New research on executive-compensation packages does not paint an especially pretty picture for many organizations, and experts say now is the time for HR leaders to be “talking their talk” with company leaders about aligning compensation to long-term value creation.

Human Resources Executive

Last October, dissident investors helped to send Darden Restaurants’ entire board of directors packing. In 2012, activist investor Carl Icahn targeted Netflix and demanded the company do nothing short of sell itself. Currently, David Winters has his sights set on major changes at Coca-Cola. And according to FactSet Shark Watch, activist investors launched as many as 238 campaigns to make changes at companies in the first nine months of 2014, a pace not seen since 2008.

And, while perhaps not evident at first glance, there is a way HR executives can help tamp down such roiling campaigns.

Experts say HR leaders can help put a stop to such efforts by ensuring their companies maximize their resources and focus on rewarding long-term performance more accurately and effectively, thereby reducing the risk of investors claiming companies are underperforming or in need of major repair.

At least that's the message Mark Van Clieaf hopes HR executives take from his recent research about performance-based pay. 

Van Clieaf, a Tampa, Fla.-based partner for the Americas and chief knowledge officer at Organizational Capital Partners, recently teamed with New York-based Investor Responsibility Research Center Institute to take a deep dive into data on executive compensation. Their findings do not paint an especially pretty picture—and perhaps help explain the hyperactivity of activist investors.

He says that as many as 80 percent of S&P 1500 companies are not measuring the right metrics, over the right period of time, for performance-based compensation. The metrics of choice for most companies are total shareholder return and earnings per share—the problems with both being that the former merely measures movement of capital markets (over which executives have little control) and the latter fails to capture future-oriented value creation. And only 10 percent of "long-term" incentives in current public-company compensation packages measure beyond three years.

Van Clieaf's message is that companies are failing at more than just compensation-plan design, they also fail at building for long-term growth. Nearly half (47 percent) of all S&P 1500 companies do not produce returns on their capital greater than their cost of capital.

"Which means they did not create real value," Van Clieaf says, adding that HR executives should see this as a “significant opportunity” to prove their mettle to the chief financial officer and the CEO by “talking their talk” about strategic performance and how to align business strategy with long-term value creation. 

It's about giving executives a clear line of sight to controllable metrics that can signal long-term organizational success, he says.

But while Gregg Passin, U.S. leader of Mercer's executive compensation practice in New York, concedes that the facts might be straight in the IRRCi, he doesn't believe they’ve been interpreted to tell an accurate story. By limiting itself to metrics measured in compensation packages, Passin says, the research fails to account for metrics that companies are measuring outside of performance-based pay.

"It's a conversation that we have with our clients all the time," he says in regard to what metrics organizations should include in their compensation packages, as not everyone in an organization can be included in such pay programs, and those who are left out can, and often are, still monitored.

What's more, HR leaders would be aware of what’s being monitored, whether part of compensation or not. They would already be in conversations with finance, the CEO and other senior executives about the company's strategic performance—the very same sort of dialogues that Van Clieaf is calling for.

Passin agrees that TSR is a measurement that's prevalent "globally" in performance-based compensation, but adds that compensation packages often couple TSR with metrics that reveal a company’s true economic performance and improve executives’ line of sight to value creation.

But, he says, it’s difficult to generalize about how to structure performance-based compensation packages because each company's size, industry, competitive landscape, strategic goals and countless other individual factors go into determining its parameters.

Still, HR leaders would be remiss not to consider Van Clieaf's recommendations, as they are based not only on data, but best practices too.

For a data-based recommendation, Van Clieaf points to his finding that three out of four S&P 1500 companies fail to use a balance-sheet measurement in compensation. Return on invested capital is one of—if not the best—of the bunch, he says.

The IRRCi report also calls for companies to measure innovation and its impact on long-term value creation, and Van Clieaf advises HR leaders to look at how other companies are doing it, adding that companies such as Abbott Laboratories, 3M and John Deere all measure revenues and other results from products and services that had not existed a few years ago in order to determine performance-based pay. That should send a clear signal to any organization’s senior leadership that they ought to be focused on not just the current business, but where future growth will be coming from, he says.

At the very least, HR executives may want to consider rejiggering their performance-based pay structure simply to generate greater effectiveness. 

In a recent blog post, management consultant Andrew Jensen at the New Freedom, Pa.-based Sozo Firm Inc. cites research from Michael Beer and Mark Cannon that shows how compensation programs in place for long periods of time can generate complacency and entitlement, rather than improved performance.

“The reason behind this is that, when faced with an ongoing performance-based pay system, many employees adjust to it very quickly,” Jensen writes.

What's the potential downside to not reviewing a performance-based compensation system? 

Van Clieaf says he strongly believes the world is changing, regardless of whether companies are changing alongside it, and boards and investors will only continue to ask "uncomfortable but right questions." 

Sooner or later, he says, all underperforming companies will be put under the compensation microscope. 

His question to HR leaders is a simple but proactive one: "So why wait for that [to happen]?"

Compliance Week Column - 9 December 2014

Metrics Misused: The Executive Pay Example

Stephen Davis and Jon Lukomnik | December 9, 2014

Here is a fact, not an opinion: Creating sustainable, long-term value turns out not to be a central driver of executive compensation today.

As counter-intuitive as that observation seems, it is the core finding of a recent report which focused a white-hot spotlight on “The Alignment Gap Between Creating Value, Performance Measurement, and Long-Term Incentive Design Sustainable.” Written by Organizational Capital Partners in collaboration with the Investor Responsibility Research Center Institute, the study builds from a premise familiar to anyone who has taken Finance 101: Value creation demands that return on invested capital (ROIC) be greater than the weighted average cost of capital (WACC). You can survive for a period of time, perhaps even an extended period of time, burning through capital. Indeed, many start-up companies, and even new projects within established companies, do so. At some point, however, a company needs to become profitable. So you would think companies would incentivize their senior officers to achieve real economic profitability, but they don’t.

Simply put, three-quarters of large public companies do not use any balance sheet or capital efficiency metrics in their long-term incentive plans (LTIPs). As a result, boards can have no idea whether value is being created or destroyed when they approve bonus payouts. Perhaps as a result, researchers found, only 12 percent of the variance in CEO pay is attributable to economic performance. By contrast, about five times as much is explained by factors such as company size, industry, and pay level of the previous CEO.

Divorcing pay from performance has real-world consequences—troubling ones. Nearly half the companies in the S&P 1500, some 47 percent, actually destroyed value by earning a ROIC less than their cost of capital over the five year period ended 2012.

How did we get to such a state? In short, boards, institutional investors, and proxy advisory firms have insisted that executive compensation center around “alignment” of CEO and named officer compensation with short-term market returns, rather than on creation of economic value over time. One indication is that total shareholder return (TSR) has become, by far, the dominant metric for incentive compensation, despite TSR’s having nothing to do with value creation, when you think about it.

TSR is, instead, a post-hoc measure of the co-movement of stock price and dividends compared to executive pay. If TSR declines by 9 percent, and executives get paid 9 percent less, that’s perfect alignment. (Although nobody—not the CEO, not investors, not the board—will be happy.) Compounding the problem is that executives can’t manage to TSR; their decisions can have only so much affect on stock price. Exogenous factors ranging from Federal Reserve Bank monetary policy, to Russia’s actions in the Ukraine, to the flow of funds into the market, all affect TSR. Yet TSR is a key metric in more than half of all LTIP plans, more than any other measure.

When investors began advocating for alignment a quarter of a century ago, there was an assumption that corporations were run for long-term value creation. Alignment was a secondary goal; investors wanted to make sure the economic profits were fairly apportioned. Somewhere along the line, however, alignment—and TSR—rose to prominence, despite it being uniquely ill-suited as either an incentive or a performance metric.

Advocates for TSR note that it is observable, objective, and measurable. That is all true. But it is also irrelevant; lots of measures boast those attributes. 

Advocates for TSR note that it is observable, objective, and measurable. That is all true. But it is also irrelevant; lots of measures boast those attributes. If you lined up CEOs and measured their times in a 40-yard dash, those results also would be observable, objective, and measurable, too. And they would have about as much to do with real value creation as TSR does

Fight for the Future

What does drive value over time? First, as noted, earning an ROIC greater than a company’s WACC drives value. But remember that a company’s total enterprise value is comprised of two parts: current value and future value. Current value is obvious; it is the net present value of existing economic profit plus capital invested to date. Future value is a bit more complicated. It is the net present value of the not-yet-achieved cash flow from things such as new products or services, future efficiency gains, new markets, and other gains. Future value is also often related to a key intangible: the perceived quality of management. And as tricky as assessing future value might be, it is a vital component in the expansion (or contraction) of price-earnings multiples for public companies. Indeed, depending on the corporation, it can represent 25 to 70 percent of total enterprise value.

Moreover, unlike TSR, drivers of future value (such as new product development) are things that senior management can directly affect. Astonishingly, however, only about 15 percent of large companies include such operating metrics in their LTIPs, the new study found. Perhaps as a result, major inputs into the creation of future value such as research and development investment and net new capital expenditures have declined from 2.9 percent of revenue in 1998 to 1.7 percent in 2012. That is a 41 percent decline on a revenue-adjusted basis. Senior managers are by and large not rewarded for those kinds of investments.

Perhaps we shouldn’t be surprised. When you take a step back, a theme runs through the findings, that boards have placed strong emphasis on short-term stock price movement. Consider, for example, that 90 percent of large public companies don’t even have a performance period for compensation of more than three years. Even worse, roughly one- quarter don’t even have multi-year performance periods, preferring to use time-restricted stock options.

Just as not measuring capital efficiency has had real-world effects, the combination of a lack of incentives around future value, combined with the short-term nature of most supposedly “long-term” compensation, has also had an effect. Median future value of the S&P 1500 has shrunk from 50 percent of enterprise value to 27 percent in the dozen years ended 2013.

What can a board do to reinvigorate executive focus on creation of long-term value? Start by focusing on the drivers of sustainable growth in enterprise value: Earning a return on invested capital greater than the cost of that capital, and on innovating so as to drive future value. Then, align your performance measurement periods to the time frame over which those innovations will pay. That’s usually more than three years.

In other words, measure the right things and measure them over the right time periods, even if such a course takes you astray from short-term templates crafted by some investors and proxy advisers. Then invest the time and resources to explain that strategy to your long-term investors; big funds today are more than likely to agree with a persuasive case made by credible directors and pitched to best serve shareowner value. Along the way, you might just manage to shake off the tyranny of TSR and short-term stock price movement.

Corporate Governance (CorpGov.net)

CEO Pay: Link to the Cost and Future Value of Capital

Total shareholder return (TSR), is the most frequent metric used to pay CEOs for performance. The authors of this excellent study from IRRCi believe CEO pay should, instead, be linked to the cost and future value of capital.

CEO Pay for ‘Performance”

In 1993, Congress amended the tax code to tie executive pay to “performance” metrics. To be a deductible business expense, pay had to be linked to performance. Stock price was an easy proxy for performance and the link was acceptable to the IRS. Before the amendment, in 1991, average CEO pay at large public firms was 140 times that of average employees. By 2003, it was approximately 500 times. Whereas equity-based compensation at such firms was zero percent in 1984, it climbed to 66% by 2001. The percentage of CEO pay from stock option grants rose from 35% in 1994, to 85% by 2001.

As the authors point out, “total shareholder return is, by far, the most dominant performance metric in long-term incentive plans.” Yet, increased TSR often has little to do with actually growing a business for the long-term. The rise of fall in stock price generally has little to do with CEO effort. When there is effort involved, rewards come quicker through cost-cutting (firing employees, reducing R&D), stock buybacks or financial engineering than by developing new products, training staff or increasing sales.

Click here for more details

WSJ - 21 November 2014 - What’s a CEO Really Worth? Too Many Companies Simply Don’t Know

Link to the article, click here

Verhouding bedrijfsresultaat en beloning

NU.nl - 23 November, 2014 - for full article, click here
Bij veel bedrijven ligt de verhouding tussen bedrijfsresultaat en de beloning voor de bedrijfstop scheef, omdat ze de beloning van hun CEO aan de hand van niet-prestatiegerichte cijfers vaststellen.

Dat blijkt uit Amerikaans onderzoek, waarin de resultaten van de 1500 grootste beursgenoteerde bedrijven in de Verenigde Staten worden vergeleken met de beloningen die hun CEO's ontvingen.

De onderzoekers komen tot de conclusie dat een meerderheid van de bedrijven geen prestatiegerichte meetwijze hebben om te bepalen hoeveel waarde hun CEO aan de onderneming toevoegt - en dus ook niet weten welke beloning hier tegenover moet staan.

De conclusies zijn ook op Nederlandse bedrijven van toepassing volgens Karel Leeflang, die als partner bij Organizational Capital Partners betrokken was bij het onderzoek.

How can investors and boards effectively manage for the long term if most performance metrics and incentives are geared for the short term? Mark Van Clieaf advises boards and long horizon investors how to design CEO accountability and corporate governance

Corporate governance is about long- term value creation for customers, shareholders and broader society, not about compliance. However, directors of investee companies are still spending too much time focused on ‘compliance governance’. Compliance and oversight should only be a small subset of a director’s fiduciary duty to ensure that the business and affairs of the corporation are managed ‘by and under the direction’ of the board. 

Download the full article by clicking on this link

© 2014 Organizational Capital Partners 

Total Shareholder Return and Management Performance: A Performance Metric Appropriately Used, or Mostly Abused?

This article by our partners Roland Burgman and Mark van Clieaf identifies the complex issues associated with the unconsidered use of total shareholder return (TSR) as a metric to represent the gains (or otherwise) in shareholder wealth and in contexts such as long-term incentive compensation and proxy voting by shareholders (including “say on pay”). Not all TSR is created equal. Other measures, such as economic profit (EP), return on invested capital (ROIC), and future value (FV), need to be introduced to effectively interpret the quality of TSR. There are not one but eight states of the quality of TSR, and this has implications for effectively evaluating true pay-for-performance alignment and considered say-on-pay voting by institutional investors everywhere, including under the new Dodd–Frank legislation in the United States. 

Download the full article by clicking on this link

© 2014 Organizational Capital Partners

The Five Levels of CEO Work and Capability

CEO succession planning takes a variety of forms, but has a common underlying flaw: it treats succession planning as an episodic event only loosely related to the underlying business strategy of the company.

According to the HarvardBusiness Review, “Two out of every five new CEOs fails in their first 18 months.” Given the resultant turmoil and attendant loss of managerial focus on the business, as well as the cost of severing the outgoing CEO and, sometimes, attracting the new one, this is no small problem. CEO replacements made in such a short time period are almost always the result of business issues that have already cost the shareholders dearly. So why is such a critical board accountability being done so poorly and so frequently? 

Article by OCP partner Mark van Clieaf.

Download the full article by clicking on this link

The New DNA of Corporate Governance

The Level of Work and Level of Capability framework provides the processes, diagnostics and substance to facilitate “sustainable governance” decision-making and organizational design. We term this the “DNA” of strategic governance because it is the intertwined double helix of Levels of Work and Levels of Capability that makes this framework so effective. Those directors and officers wishing to discharge their strategic duty may find the logic and research outlined appealing. 

Article by OCP partner Mark van Clieaf and Ms Janet Langford Kelly.

Download the full article by clicking on this link

Strategic Pay for Future Value

Despite all of the controversy over excessive executive compensation, with differing views expressed by institutional investors, board members, judiciary, and media, the real issue about executive pay-for-performance has not been addressed. Most long-term incentives do not hold senior executives accountable for creating the long- term intrinsic value of the enterprise. Thus, most Chief Executive Officers (CEOs) and other Named Executive Officers (NEOs) lack any true accountability and direct line-of-sight regarding the expected value of future growth and innovation beyond the current performance of existing operations. 

Article by OCP partner Mark van Clieaf and Ms Janet Langford Kelly.

Download the full article by clicking on this link

Are boards and CEOs accountable for the right level of work?

The court of public opinion says that CEOs are overpaid. This author does not have an argument with that per se, but he does argue, compellingly, that CEOs are overpaid not necessarily because their company under-performs, but because they are being paid for work that is, literally, beneath them. Too many CEOs, he points out are paid for operational, not strategic work. In this important article, he lays out a sound blueprint for identifying the work that CEOs should be doing do and be paid for. 

Article by OCP partner Mark van Clieaf.

Download the full article by clicking on this link