Five years ago most executive compensation consultants were still discussing a more structured approach to pay for performance as if it were a pleasant, but unimportant, children’s story. There were a few vocal proponents who expressed a need to stop leaning almost exclusively on stock price. But, the crowd generally drove with their eyes in the rear view mirror instead of the mountain on the horizon. There seemed to be plenty of data showing how the old ways linked pay and performance, so there was little impetus to make material changes.
Then came the advent of mandatory say on pay votes a few years ago. Suddenly (seemingly), everyone was on the P4P bandwagon. The band was still unpracticed and had yet to come up with a consistent approach to this issue. Definitions varied widely and linkages to success were often tenuous.
As pay for performance grows up, we are seeing more structure and commonality. As we experience this, there is more focus on the lack of commonality of comment terms like “performance” and “success”. In December 2013, the NACD published a new paper covering “Pay for Performance and Supplemental Pay Definitions.” This document attempts to provide some consistency in terminology and approach, with the goal of creating better credibility when reporting executive compensation.
The paper discusses four “Pay for Performance Principles.”
- Standard Definitions (with Flexibility): This focuses on both the words and the presentation methods used. The goal seems to be to provide enough commonality to make it easy to show when doing something special.
- Consistent Time Horizons, Oriented to the Long Term: The recommendation is move away from one-year performance baselines, and focus on three and five-year periods. The goal is to clearly differentiate between short-term and long-term incentives.
- Need for Disclosure Beyond the CEO: The recommendation is to report the CEO P4P independently and as part of the full group of company NEOs. Investors want a clearer picture of executive compensation.
- Importance of Board Judgment and Company Context: No surprise here. Checking the boxes to prove you’re doing the right things seldom works well for anyone (but it sure makes initial analysis easy.) This puts even more weight on the shoulders of compensation committee members. With judgment come disagreements that cannot be satisfied with “best practice” answers.
You don’t need to agree with everything in the paper. In fact, there are several areas where they admit more work is needed. Even consistent imperfection may provide those of us dealing with executive compensation some comfort. It is time for P4P to slip off its training wheels. There will be some crashes and accidents, but a bit more definition may actually allow us the flexibility to fully explore the potential of this next wave in executive compensation.
You can access the NACD’s document here.