The Advisors' Blog

– Broc Romanek

Here’s the teaser for this Pay Governance memo:

Incentive plans have the potential to drive executives towards achieving superior results for their companies and investors. At the same time, real and perceived risks in these programs can either blunt the potential drive of management or encourage excessive risk taking. A key goal in well-designed executive incentive programs is to motivate executives to take the actions necessary to achieve strong results for shareholders while mitigating the motivation to take excessive risks.

To date, the annual report that Compensation Committees provide in the CD&A on the presence of material risk in pay programs has been based largely on overall qualitative assessments done by the Company or their independent advisor. The most common risk assessment approach has been to look at each of the major incentive design elements in isolation – such as the presence or lack of a “cap” on annual incentives – and then judge the overall risk based on the types and number of potential risk-creating elements observed in the entire pay program. This qualitative approach is a self-assessment, and rarely does it look at relative risk compared to peer companies or a comparator group.

Pay Governance has recently developed a quantitative measurement tool, tested with the Fortune100, that will generate an overall score for both Pay Energy™(the first measurement tool that identifies the degree to which any company’s pay program creates “drive, discipline and speed”) and Pay Risk (in this context, risk refers to financial risk). This can then be used as an additional diagnostic tool to evaluate the potential of a new or existing pay design to achieve an efficient balance of Pay Energy™and risk management.