In an ideal state, executive compensation is about balance. A program should encourage innovation through measured risk while also rewarding prudent cost management. Tactical successes should drive the long-term strategic plan of the corporation. However, successful plans do not exist in a vacuum and most adapt over time to market conditions, regulations, and investor sentiment. Unlike the vast majority of employee pay in the US, a significant majority of executive compensation is tied to company performance, both in absolute terms, and relative to peers or broader market. Established goals should be clearly tied to increased shareholder value and easy to comprehend. However, the best plans provide flexibility to the Compensation Committee to exercise discretion and informed judgement in times of volatility or disruptions outside of company control (such as the COVID-19 pandemic).
The market is simultaneously pulling executive pay plan design best practices in two nearly opposite directions.
On one hand, some investors and advocacy organizations are encouraging companies to simplify their performance-based incentives as complexity can obscure the link between pay and performance.
On the other hand, companies are under pressure to transition away from shareholder primacy and consider stakeholder benefits in rewarding performance. Specifically, companies are being called on to tie executive compensation to improving diversity, equity, and inclusion, as well as transitioning to a net zero economy.
Compensation is a key element of communication to shareholders and stakeholders on what the company is trying to do and what it values. Adherence to a pay for performance mentality is paramount, but corporate governance standards also emphasize the need for an actively engaged Board prepared to demonstrate flexibility in a time of crisis.
Please see below for an extensive suite of resources on designing effective executive compensation programs.
