Sure, Pay-for-Performance… but What Performance? Designing a program that rewards the right pay for the right performance represents one of the compensation committee’s most challenging activities. Yet, when it comes time to translate a buzzword into an effective process, compensation plan designers must ensure that pay-for-performance systems measure and drive valuecreating decisions.
Addressing the Top Concern of Compensation Committees
This paper’s purpose is to help compensation plan designers:
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oes our compensation plan support the achievement of our D performance objectives?
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hich performance measures align with our definition of W success?
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nderstand performance U measures and how they evolve
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Evaluate different types of performance measures
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elect optimal measures S by evaluating internal and external factors that influence performance
By Russell Miller Executive pay plans are keeping corporate directors awake at night. The top concern of compensation committees is “aligning pay more closely with performance,” according to Korn/Ferry International’s 33rd Annual Board of Directors Study. Yet the ease with which “pay-for-performance” rolls off the tongue these days masks the complexity and risks boards confront when attempting to align pay with performance. Important and difficult questions loom behind the buzzword phrase:
n Do those measures drive the right management decisions? In addition to these daunting questions, boards must contend with recent revisions to U.S. Securities and Exchange Commission (SEC) reporting guidelines. The rules require companies to provide much more detail about their executive compensation programs. In particular, publicly-held companies must now provide a clear explanation of performance-based compensation plans and their process for setting goals. As a result, compensation committees, now more than ever, need to apply greater rigor to the process of designing and communicating their executive compensation programs. In short, a larger dose of structure and science should inform pay-for-performance systems within executive compensation programs.
Understanding Performance Measures – and How They Change
Companies ultimately define performance as the creation of value. Publicly held companies often define long-term value in terms of stock price appreciation and dividends (i.e., total shareholder return or TSR). Private companies may define long-term value in terms of increases in intrinsic value (i.e., investing where returns on capital are greater than the cost of capital).