The role of the compensation committee among healthcare firms is rapidly evolving, taking on a new dimension by supporting the development of CEO and top executive talent. This new function is disrupting customary committee roles, particularly in the traditional “executive committee.” Meanwhile, as this agitation takes place, governing boards are taking advantage of the transition to streamline their committee governance processes.
In this white paper, we examine the human resources committee that is arising from the old compensation committee structure, and discuss how best to migrate toward this new framework.
What is provoking this change? And why now?
Several factors are driving the evolution of the compensation committee.
Retirement and turnover.
The most recent data available from the American College of Healthcare Executives shows the continuing trend of high turnover through 2015. Because the healthcare executive population is aging, board members are realizing they need to plan for the future— for a time when they will need to hire a new CEO and other executive leadership.
Not all of the reported turnover is based on age, however. The data includes voluntary and involuntary turnovers: While voluntary turnover can be managed by the board, involuntary turnover is more an issue of how an executive aligns with the organization’s current needs.
The velocity of such change is high. Consider that the average CEO tenure is 3.5 years, and 56% of CEO departures are voluntary. This period becomes even shorter given that a new CEO requires a ramp-up period—often ranging from six to nine months— when he or she learns about the board, the organization’s strategy, the team, and operational issues facing the organization. Black Book Research suggests these initial months also have the potential to influence the entire executive team profoundly, as nearly half of CFOs, CIOs, and COOs are terminated within nine months of a new CEO’s hire, as well as 32% of chief human resources officers and 24% of chief marketing officers.
Concurrently, the new CEO must find replacements for those spots. It may take as many as 12 to 18 months to fully form the new leadership team—a significantly long time in an industry that’s subject to rapid change and turmoil. As previously noted, if the average CEO’s tenure is 3.5 years, not much time remains for focusing on results.
Modifications to leadership structure.
Traditionally, the CEO has served as a company’s hub, while members of the executive team have acted as spokes. Yet this type of tight, centralized control is less appropriate in today’s environment, where greater fluidity is required from leadership, particularly at large, complex healthcare organizations. Ultimately, the CEO’s role is to create the conditions for C-suite members to be successful—not just to parachute in as a “deal closer” or “arbitrator.” It is about shared accountability.
An example that highlights the difference between the old and new leadership styles is the structure of clinical operations and physician practice. Though they are typically separate entities with their own leaders, in today’s environment, these key functions now have shared accountability. One cannot simply toss a problem to the other; both segments must share in the solution.
Business continuity is not only the responsibility of the CEO, it relies on a high functioning and focused leadership team that’s able to tackle the strategic and operational challenges facing the organization. Ensuring the required level of talent is a key task of the CEO, as well as the governing board.
Performance may seem like a historic issue, but it really is an emerging one, in part because reimbursement is increasingly being tied to it. The federal government has become more attentive to performance through value-based care and bundled payment programs. Meanwhile, private payers are building networks around high-quality low-cost providers. These two changes are forcing governing boards to rethink how they define and measure performance overall.
At the organizational level, the focus is on broad indices (clinical and operational efficiency and effectiveness, patient satisfaction, financial efficiency, employee and physician engagement, and community benefit). And as you drill down into the organizational hierarchy to observe individual performance, the measures become more micro. Ultimately, at that level, it is critical to be able to effectively assess the value that each person brings to support patient care.
Alternative sources for talent.
Boards today recognize that dramatic changes to the business of healthcare have resulted in recruitment that occurs outside of the traditional talent pool.
For example, one client organization has started to recruit board expertise from outside its service area for two key reasons: It needs talent that is not available locally, and it needs people who bring independence and innovation to the governance process. Another organization recruits talent based on key trends; for example, it recruited an expert on cybersecurity to help with this emerging crisis issue. A third organization has hired an expert in the latest payment processes who can help shape (rather than be shaped by) the future revenue cycle process.
Scope of growth.
Importantly, given the climate of consolidation in the healthcare industry, directors with experience in mergers and acquisitions and growth may be required. There is a difference between governing a $1 billion organization and a $10 billion one.
How can an organization, and its board, adapt to all these factors?
Healthcare is changing at a rapid pace in the US, and healthcare boards need to keep up. This change requires a holistic view and approach to talent and capability, which the establishment of a human resources committee would ensure. Reactive “approval mode” to silo issues, such as pay, is not enough anymore. The HR committee of the future will need a strong, well-thought-out, proactive strategy of ensuring the right level of executive talent for the future, pulling all the levers—capability, behavior, culture, role definition, reward, and recognition.
Once these expectations are defined, the HR committee will have to challenge its CEO to make tough and timely people decisions, not let people overstay and generally ensure that all are working to the top of their abilities. The committee would be well served to provide as much clarity as possible in relation to these requirements—for example, creating a CEO dashboard that clearly defines the success criteria of each metric. The committee would then need to evaluate the CEO on his or her ability to hold executives accountable to high performance expectations, which begs for the right people to be in the roles to make this happen.
The HR committee cannot make appropriate compensation decisions without establishing clear performance expectations. Approving pay in a vacuum or based on a history of regular increases not only sends the wrong message, but sets the board up for stakeholders’ ire. Having a unified message to support pay considerations, based on and tied to capability and performance expectations that are perfectly clear, will send the right message to management and should satisfy the most vocal external critics. It’s difficult to argue the holistic approach if it’s aligned to the right measures. Critics might not agree with your decisions, but they should at a minimum find it challenging to argue its fairness and transparency.
These issues lead seamlessly to a discussion of the competency and behavioral requirements needed for CEOs and executive management in the future.
Again, the best defense is a good offense, so clarifying current requirements provides the HR committee with a baseline for making projections. Based on what we know we need today, what will we need in the future? What external forces are lining up to drastically change how we do business? How will we deliver patient care? How will we be reimbursed? And, based on that, what will we, as a committee, expect of our CEO and senior executives? What will they do more of, less of, or differently? How will that transform us over time? The CEO and the HR committee need to work together to plot and plan for this journey. And, if the committee has been tracking such information along the way (and possesses the right set of skills to conduct this discussion in a truly productive manner), it will be in a much better position to weigh in, provide guidance and counsel, and work closely with the CEO to achieve his or her vision and mission.
What does this change mean for the existing compensation committee?
Traditionally, compensation committees have focused principally on pay. Yet, as the scope of compensation continues to evolve, committee members are raising questions specifically about performance, particularly regarding how to measure it and how to improve it. This inevitably leads to questions about the executive team—who is and who is not performing.
Healthcare governing boards have become more comfortable with asking very difficult questions, and CEO succession is one matter that is more routinely being raised. It has not been unusual for us to meet with boards and ask about this very issue, only to discover that the CEO is past 65 years of age and there are no succession plans in place. Keep in mind, it is not just about CEO succession. It is an issue for the entire C-suite; and for a forwardinglooking organization, it is an issue at every level. One study we conducted showed that the cost of all talent in some healthcare organizations exceeded 60% of their budgets.
Executive retirement is, unfortunately, not the sole reason to have a succession plan in place. There are issues of voluntary and involuntary turnover. Voluntary turnover is driven by an executive’s desire to make change. Involuntary turnover, often defined as a performance issue, also can be the result of death or disability.
As the governing board asks more questions, some committees must work on generating plans and answers. This is resulting in an expansion of the compensation committee’s role, requiring committee members to have the necessary knowledge to fulfill this responsibility.
Why not the executive commitee or some other committee?
The answer rests with a compliance mandate. Executive compensation governance must be under the control of “independent directors.” An
independent director is a person who does not have a conflict of interest. Some executive committees have members, often physicians, who are affiliated with the organization or have some other form of conflict of interest. Properly constructed compensation committees have members who do not have any type of financial interest in the organization, are not major contributors, and are able to exercise their duties with the best interest of the organization.
The reason the compensation committee has taken on this vital task is because many of the issues they deal with overlap executive-level human resources issues.
What are the key functions of the HR committee?
1. Establish a compensation philosophy.
Define and monitor the compensation plan’s objectives and goals. Also define the roles covered by the philosophy. Include the desired comparison markets (including peers for pay and performance comparison purposes) and the design of the program (which includes salaries and any incentive or deferred compensation, benefits perquisites, employment terms and conditions, and any other issue involving the financial relationship between the organization and
any person covered by the philosophy).
The philosophy will cover, at minimum, all disqualified persons as defined by appropriate federal regulation.
2. Establish compensation levels.
Approve proposed compensation levels on a total remuneration basis and any variable compensation payments prior to the transfer to individuals covered by the philosophy. All compensation payments will be based on the review and approval of the performance of individuals covered by the philosophy.
3. Review and approve any changes to the compensation plan.
The committee will review and approve any and all plan changes prior to acting on them.
4. Ensure compliance.
Meet requirements at both the federal and state levels to ensure compensation decisions meet all compliance requirements.
5. Fulfill reporting.
Report the actions of the committee, within your board policy, to all members of the board of directors. Ensure there is a proper communications plan in place if any inquiries are submitted by outside parties, including the press. Review and approve the IRS Form 990 prior to its submission.
6. Select and retain outside advisors.
This includes the compensation consultant and any independent legal advisors who will support the committee.
Human resources management.
1. Define the scope.
Identify which executive positions will be included under the purview of the committee. At aminimum, these should include all “disqualified persons.”
2. Work with the CEO.
Directly manage all aspects of the employment relationship between the CEO and the board. Support the CEO and work jointly to achieve the organization’s strategic goals. Serve as a key advisor to the CEO. Establish the compensation program for the CEO, including setting strategic and tactical goals to support the mission and vision of the organization. Establish and monitor performance metrics, and ensure the appropriate reward for the services received.
3. Cultivate executives.
Come to an agreement with the CEO on his or her role and that of the committee in the development and execution of the executive human resources program. Have the CEO conduct, at least annually, a review of each executive and his or her future roles, related development needs, and succession plan to collectively ensure leadership continuity.
4. Monitor overall performance.
At least quarterly, assess organizational performance to identify deviations from the plan. Understand and support the CEO in developing plans to address course direction, as required. Track performance on a longitudinal basis to ensure understanding of the longterm trend. Focus on the use of relative peer measures that align your organization’s performance with that of similarly situated organizations.
5. Prepare for succession.
Establish and monitor the CEO and executive succession plan, addressing planned and unplanned changes. Ensure that the plan has depth, specifying several possible short- or long-term successors. Have a plan in place to conduct CEO recruitment, and be prepared to support the CEO when recruiting top executive talent.
Specify the processes that need to be followed, including the selection of an executive search consultant, the scope of the search (internal or external), the process, when and how candidates will be vetted, how compensation parameters will be set and negotiated, and which director(s) will take the lead in finalizing the recruitment.
6. Report plan status regularly.
Inform the full board of the HR committee’s plans.
This information should be communicated periodically, at least on an annual basis.
How does an effective and efficient committee manage processes?
Maximizing the contribution of independent directors takes planning and discipline, particularly in the healthcare field. This is best achieved by recognizing that the committee will need to meet at least quarterly (or some years more often, depending on the issue), and then setting up a well-defined calendar of events. For example, one year’s schedule might roughly look like the figure below.
Another key task is to support the members in their work by compiling detailed meeting agendas and comprehensive information packets. For example, in our client engagements, committee packets aretypically sent out one week in advance (either paper or electronic, depending on the committee member’s preference). This way, each member can anticipate when the information will come in and be able to read and digest the data with a minimum amount of pressure. To make this happen, the executives involved—and we as consultants— must work to ensure that the packets are reviewed, approved by the committee chair, and distributed.
Making the pieces come together for a committee to operate smoothly takes fortitude. The governing board exists to set direction and establish policy, while it is the role of the CEO and the executive team to manage policy. All too often we see the CEO focused on managing their board rather than drawing upon the board’s expertise and insight. Building a workable management process is key, and it requires the board and committee chairs to set the conditions under which they will govern. A reasoned and appropriate governance approach requires care and planning, as we work to enfranchise the compensation committee in meeting their governance obligations.