The Advisors' Blog

– Broc Romanek, CompensationStandards.com

Here’s an excerpt from this piece by Semler Brossy’s Seymour Burchman and Blair Jones:

Compensation committees are often tempted to follow conventional wisdom and follow how other companies, especially peers, have traditionally structured their payouts, using either a symmetric payout curve, or a payout curve with equal ranges above and below target. Two practices are common: using 90 percent of target for threshold and 110 percent of target for maximum or using 80 percent of target for threshold and 120 percent of target for maximum. Executives then usually get 50 percent of their target bonuses if they achieve the lower level and 150 or 200 percent if they achieve the higher one. A cap of 200 percent helps compensation committees avoid encouraging unacceptable risk-taking and paying too much for windfalls.

Because thresholds and maximum payout levels need to take into account many factors, particularly the relative predictability and volatility of performance outcomes as well as investor expectations, compensation committees need to move beyond conventional practices. They should instead use analyses that are tailored to their company.

For example, consider the case of a branded food company with stable revenues. This company has launched several high-growth, albeit unproven, initiatives to develop innovative products in new categories in addition to expanding geographically. For years, executives have delivered predictable results which were rewarded by payouts fitting a narrow symmetric payout curve, one with a 95 percent threshold and 105 percent maximum. (See Figure 1.) As a result, the compensation committee considers whether, and how, to adjust the range in light of the shift to a strategy with less predictable outcomes.