Rigorous metrics, thorough disclosures and strong links of metrics to long-term business goals are three critical components that Vanguard’s Investment Stewardship team cites as key expectations in designing executive pay plans.
Vanguard’s philosophy is that a well-structured, performance-based, and transparent compensation program is a fundamental driver to a company’s long-term success. While recognizing there is a not a one-size fits all approach, the investor considers the following best practices to evaluate how well your compensation program aligns with shareholder outcomes.
- Rigorous Metrics: The Compensation Committee should determine the appropriate set of metrics based on the company’s strategic plan and industry. While metrics in both relative and absolute terms may be appropriate, compensation outcomes should align with performance compared to the relevant peer group. A rigorous goal setting process is required with target pay in line with reasonable and market competitive levels.
- Thorough Disclosures: Investors are trying to understand the “why” behind the metrics that a compensation committee chose; clear explanation about how a particular metric aligns with strategy or addresses a material risk is critical. It can even be helpful to disclose why a metric was considered and not selected and who was involved in the decision-making process. Discretionary adjustments (up or down) could signal to investors that the plan structure is not effective enough to drive outcomes. These adjustments should also be disclosed thoroughly with a clear explanation behind the rationale.
- Long-Term Focus: Incentive plans should emphasize long-term value creation and how all metrics –financial and nonfinancial - align with business strategy or address significant risk. Vanguard does not expect that all companies will include ESG metrics in their compensation programs, but those that do should use the same amount of thoughtfulness as they do when selecting financial metrics and be able to clearly articulate the link to long-term shareholder value.