Recruiting isn’t often considered a remit for compensation committees. But a new book suggests they should be precisely that—and more.
In Talent, Strategy, and Risk: How Investors and Boards are Redefining TSR (Harvard Business Review Press), coauthors Bill McNabb, the former chairman and CEO of the investment firm Vanguard, renowned business advisor Ram Charan, and Korn Ferry vice chairman Dennis Carey argue for a radical rethink of the compensation committee’s responsibilities. Since talent is so critical to firms—driving strategy, fostering innovation, and managing risk—the writers say comp committees “should be scrutinizing talent every time they meet,” as well as take on other roles. The following is an excerpt from the book:
In meeting its responsibilities, the board has a singular constraint: time. A typical board might meet for only 50 hours a year—nowhere near enough time to develop the depth of knowledge necessary to oversee talent, strategy, and risk. As part of its new playbook, the board should elevate the work of its committees so that the directors can dig deep and manage their agenda and stakeholders from outside the company can better understand the board’s work.
The job of the compensation committee, at its most basic, is to hold management to account. To do so, it must develop the depth of knowledge about the company’s operations so that the full board is better prepared to make sense of management presentations, drawing on data from both inside the company and from the wider marketplace. Unfortunately, most boards lack this wider focus because they address talent, compensation, and execution separately. The reality, however, is that these key functions ought to be coordinated. To be sure, one of the first things Ron O’Hanley of State Street says his firm looks at regarding boards is “how effectively they go about overseeing the talent acquisition and development process.”
Revamping the compensation committee to include talent and execution expands its directors’ remit to include overseeing recruitment and pay of senior management and monitoring their performance. Moreover, tying all three together under the purview of one governing body can help improve management by linking execution with key talent and aligning compensation accordingly.
For instance, say a product launch turns out to have been better than budgeted. The committee can ask the CEO about the people who oversaw the launch and how the company is compensating them, giving it more concrete knowledge about key talent. Conversely, say a product design failed. Why did it fail? If the manager can answer that question, now the committee knows that this is a person who can understand and explain why something went wrong.
In terms of specific benefits, this new design gives the committee a better understanding of the changing mix of long-term capabilities the company will need and the pathways for improving talent as conditions change, for example a mechanical engineering firm needing to transition to software engineering. A more expanded talent outlook can also help boards prepare for CEO succession, with the committee identifying and learning as much as it can about second- and third-generation CEO candidates and their development paths. Looking further ahead, the committee could identify candidates for other essential senior posts—the CFO and the CHRO primary among them. In addition to internal candidates, we also recommend the committee map out the top three external candidates for such positions in its industry in case its own should leave, and it should track them, like football players. Indeed, it should apply the recruiting principles of sports teams to its executive team.
From a compensation perspective, the expanded remit can help the board maintain control over company compensation. Once the committee knows the talent in the company, the CEO won’t easily be able to deviate from the committee’s assessments. By developing knowledge and a database about talent both inside the company and among its competitors, the committee will build the expertise necessary to represent shareholders.
Relatedly, a key role of the new committee will be to monitor and measure execution over time, identifying the causes of failure and success in each of the company’s lines of business relative to its peers. Such rigorous analysis can help the CEO detect unacceptable behavior by management, such as units that pull results forward from future periods to meet quarterly estimates or that cut ads just to hold down current expenditures. In other words, the committee will help the CEO perform a culture audit.
We recommend this new committee meet quarterly. If the directors on the committee evaluate performance four times a year, they will learn the business in depth—and that knowledge will give the company a competitive advantage. Ed Garden, co-founder of investment firm Trian Partners, says that the compensation committee is the most important one on the board because it has the power to influence management behavior. By aligning compensation with talent development and execution, this new committee will have the power to influence the company’s overall performance.