Pay for Performance: The Debate Continues

In the latest salvo in the continuing battle over the efficacy of performance-based pay, Pay Governance’s Ira Kay maintains that “executive incentive payouts are aligned with shareholder outcomes” over the past six years.

What they’re saying: Pay Governance’s study addresses recent research by ISS and others showing that annual and long-term incentive payouts do not in fact align with stock performance over time.

• The ISS research pointed out that in 2022, more than 70% of S&P 1500 CEOs achieved at or above-target AIP payouts despite a challenging environment, and that this level has remained more or less unchanged over the past five years.
  
  
• ISS argued that this reflects “earnings management” and mediocre goal-setting

But wait: Pay Governance’s research shows that S&P 500 companies with above-target payouts also had higher TSR compared to lower-paying peers. Also, only 3% of companies “persistently paid above target” over the 5-6 years.

• The research points out that annual incentives should not be compared to annual TSR, and notes that of the companies paying at/above target, 72% had positive TSR and 28% had negative TSR over six years.
  
  
• The authors also highlight the impact of providing investor guidance – exceeding annual guidance generally leads to increased stock price, but if a company consistently exceeds guidance, the market may assume targets are too easy and respond negatively over time.

Who’s right? The dueling studies look at different peer groups (S&P 1500 vs S&P 500) and, most important, have differing definitions of pay-for-performance. ISS is focused on alignment with TSR, while Pay Governance points out that annual awards may not always be directly linked to TSR as they are “designed to promote future success.”

• This is a key difference in how proxy advisors, investors and issuers may view the purpose of incentive pay (i.e., reward vs. incentive).

Bottom line: While we appreciate PG’s optimism, the fact is that proxy advisors in their current form will always flag companies whose financial metrics are not aligned with TSR, even over the short term. Companies should continue to use tools like Equilar’s IPAC to analyze how strongly annual and long-term metrics correlate to TSR among industry peers over time.