October 4, 2018

NACD Directorship – Dare to Be Different: Strategic Compensation Plan Design

By Robin Ferracone

The criticism of executive compensation plans these days is that they are too homogenized. Our post–Dodd-Frank governance landscape, proxy advisor policies, and even investor guidelines have conspired to create a rules-based environment for executive compensation design, pushing most companies to a new, formulaic normal. Take a short-term incentive plan with two financial measures and perhaps an individual component, mix them with a long-term incentive plan comprised of two vehicles with three-year overlapping performance/ vesting. Repeat every year, and presto, you have the typical program. Such homogeneous plans have been useful in that they have helped companies stay under the radar with respect to proxy advisor criticism and say-on-pay votes.

The good news is that the tide is changing. Investors are now asking for compensation programs that more strongly reflect a company’s strategy and even social objectives without, of course, sacrificing returns. At a recent roundtable organized by the Council of Institutional Investors, one investor commented, “All companies are different, and yet we’ve seen homogeneity in the way they’re structuring their [compensation] packages…I would like to see programs designed individually by companies.”

Pursuant to the Tax Cuts and Jobs Act, we’ve also seen the repeal of the exemption under Internal Revenue Service Code Section 162(m). This exemption allowed performance-based compensation over $1 million to be tax deductible by corporations for certain top executives. Now, compensation over $1 million for certain executives is not tax deductible under any circumstance, so there is less pressure to meet the very specific design requirements prescribed by 162(m).

These changes are not a license for excessive compensation or an “anything goes” design, but they do invite different and more strategically aligned executive compensation programs. In addition, companies are starting to recognize that customized pay plans offer them an opportunity to communicate key strategic and cultural priorities. While strategically differentiated compensation programs are not yet the norm, examples of these types of programs exist, and they make creative use of the following elements:

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