The Advisors' Blog

– Liz Dunshee

The repeal of Section 162(m) means that there’s no longer a tax reason for companies to stick to objective financial metrics for incentive plans. And although institutional investors and proxy advisors continue to prefer measurable “performance-based” pay, some shareholders have also been advocating for pay structures that would incentivize achievement of E&S goals. This blog from Pearl Meyer’s Jim Heim says that, based on an informal survey with 138 responses, compensation committees and boards might have some appetite for change. But don’t expect any big shifts in the near-term. Here’s more detail:

– A sizeable minority (35% of board respondents and 25% of management respondents) affirm that they either anticipate or have already determined they will place greater emphasis on non-financial criteria in 2019. We suspect that very few of these respondents will use such non-financial measures as the cornerstone of their incentive plans. Instead, they are likely to incorporate individual or strategic goals as a modifier (e.g., increase or decrease calculated payout by 10%) to financial result-driven formulae, or as stand-alone goals that account for less than 25% of total incentive plan opportunity.

– There is a stark contrast between the percentage of management respondents (40%) vs. board respondents (19%) who simply indicate they are not considering this approach. This echoes earlier polls we have conducted which indicated that boards are more open to consideration of ESG (Environmental, Social, and Governance) measures than management teams, possibly because they feel they are under pressure from the investor community to at least explore the topic.

Jim goes on to note that shareholders are receptive to qualitative measures if the company can clearly articulate the goals, how achievement would yield shareholder value, and how the compensation committee ensures performance is rigorously assessed. If you’re thinking of going down this path, here’s some planning advice:

Companies that are contemplating a shift in the mix of measures included in their incentive plans would be well served to stress-test these designs (modeling various performance and “what if” scenarios) before the end of the year. Where non-financial statement measures are part of the mix, we encourage companies to game plan for pay disclosures. How might the new plan design be described in the CD&A section of next year’s proxy statement? Would the board support above target payouts on such measures even if the pay trend ran counter to income statement and/or shareholder return trends? How would such a result be explained to the investor community?