Center On Executive Compensation
News

Innovation in Pay Design: Pushing Back on “Cookie-Cutter” Approaches

It’s time to take a step back and re-evaluate the current compensation paradigm, according to a new Meridian piece on the link between shareholder value and compensation strategy. The article explores the dynamics that have led to the “cookie-cutter approach” in the design of executive compensation programs and makes an argument for decoupling goal-setting from pay, allowing executives to “let go of bonus-driven priorities and behaviors and focus on the long term.”

Naturally, compensation committees spend tremendous effort developing incentive plans aligned to today’s gold star standard: targeting median of the market, evaluating performance over annual and three-year periods and measuring against TSR.

But, the article suggests, if plans are uniformly designed with the primary goal of avoiding an “against” recommendation from ISS and Glass Lewis, which can result in up to a 30% drop in Say on Pay support, there is a missed opportunity to create a plan that better drives long-term value creation.

The authors propose that boards put too much emphasis on establishing goals, leading to short-termism. Even LTI plans are measured against the 1-3 financial goals viewed as the most closely related to stock price and dividends but may not necessarily drive an executive’s behaviors to focus on innovation and enterprise-wide goals that could truly add to long-term value creation.

A new plan design option is provided with the following considerations:

  • Part A: Cash Compensation. Fold cash bonus into salary to eliminate the short-term incentive allowing executives to turn their focus to longer term objectives. The included example is to shift the mindset of a CEO and CFO from “How do I deploy capital in this 12-month period to maximize returns?” to “What can I invest in today that might pay dividends 5-10 years from now?”

  • Part B: Equity Compensation. Replace the annual long-term incentive grants with a grant comprised of 5+ years of equity awards consisting of stock options and restricted shares designed as a “compelling equity stake” and incentive to focus on the future while removing the short-term goal setting process.  

Such a bold plan design should only be considered if management and the board have a shared vision on what creates long-term value. Companies that deviate from the plan design norms will face skepticism from many investors so they will need to proactively communicate the why behind this approach to shareholders.

Published on: October 28, 2022

Authors: Megan Wolf

Topics: Executive Pay Plan Design

Megan Wolf

Director, Practice, HR Policy Association and Center On Executive Compensation

Detailed Bio

MORE NEWS STORIES

Poking Holes in Performance Plans
Executive Pay Plan Design

Poking Holes in Performance Plans

November 11, 2022 | News

Continue reading this content with the Center On Executive Compensation Membership package