January 3, 2019
Forbes – Dare To Be Different – Strategic Compensation Plans
This post originally appeared on Forbes.com.
I’m often asked why so many executive compensation plans look the same. The answer is that in the post-Dodd-Frank era, proxy advisor policies and even investor guidelines have created a rules-based environment within which to design executive compensation programs. This pushes most companies to adhere to a common formula, comprised of a short-term incentive plan based on two financial measures, and perhaps an individual component, coupled with two long-term incentive vehicles with three-year vesting. Conforming to this structure has helped companies stay under the radar with respect to Say on Pay votes and proxy advisor criticism. However, it has had the effect of largely homogenizing executive compensation.
Fortunately, the tide is shifting as investors start looking for compensation programs that better reflect a company’s strategy. Customized plans offer companies an opportunity to message high-priority strategic and cultural imperatives, while also signaling the importance of innovation. Although these differentiated plans are not yet the norm, examples of these types of programs exist, and typically differentiate in at least one of the following areas:
- Performance measures
- Time horizon
In the area of performance measurement, companies typically use two or three financial metrics that drive shareholder value. However, some companies are beginning to integrate non-traditional financial metrics. Examples include economic value added or long-term cumulative, rather than point-to-point growth measures (which decreases the impact of external economic factors in any given cycle), among others. In addition, companies are more liberally using strategic measures, which help communicate key strategic themes. Examples include customer experience and diversity.
With respect to time horizons, companies have increasingly geared their long-term incentives toward three-year overlapping performance and vesting cycles. Now that a three-year time horizon has become the norm, it is difficult to compete in a hot talent market with incentives that pay off in longer than three years. Still, some companies recognize that their investment time horizons run longer than three years and do so through innovative vesting provisions.
Finally, it is important to note that companies with high wealth leverage (i.e., the sensitivity of management’s wealth to the company stock price) tend to outperform those with low leverage. Companies typically achieve wealth leverage by implementing ownership guidelines. However, some companies are going a step further and treating ownership as a carrot instead of a stick. These companies typically offer a premium for taking cash awards in the form of equity that cannot be liquidated for some period of time. Companies that dare to be different drive a culture of ownership, creating a desire for employees to think and behave like owners.