One of the most critical of the Compensation Committee’s responsibilities is to ensure that incentive programs are appropriately structured for the company and discourage executives from taking “excessive risk.” In light of 2009 SEC regulations requiring analysis of risk for compensation programs aimed at employees below the executive level, not to mention a number of high-profile scandals, many companies go a step further and disclose specifically how their compensation plans address risk. The Center’s Charlie Tharp has created a checklist to help guide Compensation Committees on these issues. For 2022, we have updated the checklist to include risks related to the use of non-financial metrics in incentive plans. Primary suggestions for managing and mitigating risk include:
- Balance performance and the quality and sustainability of such performance.
- Balance annual and long-term incentive opportunities to avoid too much focus on short-term.
- Ensure pay and performance are aligned relative to peers and annual and long-term incentive goals are aligned and not contradictory.
- Check for overly leveraged long-term or equity incentives; ensure meaningful stock retention and effective recoupment policies are in place.
- Ensure the Committee discusses the concept of risk when designing pay and approving payouts.
- Carefully review non-financial metrics, such as DE&I, safety, and climate, to ensure there is no motivation for participants to engage in unintended actions to achieve them.
The checklist provides detailed explanations and suggestions for each element of risk and how it may be best mitigated. Risk assessments should be conducted annually and comprehensively to ensure the company is protected.