The Advisors' Blog

– Liz Dunshee

This recent report from the CFA Institute takes a look at progress on “short-termism” since 2006 – a concept that originally targeted the pitfalls of practices like sacrificing R&D and hiring to meet quarterly earnings targets but has now evolved to encompass long-term sustainability. On the executive compensation front, the report’s contributors (investors and various corporate governance leaders) concluded that say-on-pay and majority voting for directors have helped drive increased engagement – and “egregious” practices like tax gross-ups are now pretty rare. Progress! Now, though, the hurdle is complexity. Here’s an excerpt:

The consensus of the group focused on the complexity of many pay packages as the most pressing ongoing problem, noting that compensation consultants employed by most companies to design compensation plans are not paid to come up with simple pay plans. Those around the table stressed that it can be simple to align pay to performance, but that such an outcome rarely happens.

According to the group, compensation often focuses on share price but not on shareholder value. The group appreciated pay packages in which executives (and board members) had to buy shares in the market with their own money and hold them for a long period of time. Such a structure is one of the best ways to align management incentives with shareowner interests.

Investors acknowledged that annual targets are needed for metrics linked to pay, because that is a time period that management should feel is somewhat under their control. A large and often majority share of compensation, however, should be tied to a shared incentive with shareowners. Investors want to ensure that compensation is aligned with the long-term execution of strategy. If benchmarks are changing year to year, or compensation goal bars are being lowered, investors see these as red flags.

Succession planning was noted as a key responsibility of a board that has a major influence on a company’s compensation strategy and its long-term strategy. Firms that do a poor job of succession planning often have to go into the market and overpay to induce a manager to leave their current situation. Strong succession planning also signals to investors that companies are managing for the long-term success of a company by taking the time to pick and groom internal candidates that can seamlessly execute on the company’s long-term strategy.

The report goes on to discuss some hesitancy around further complicating incentive plans by adding ESG metrics that don’t have a clear link to value. The takeaway recommendation is that companies work with investors to simplify executive compensation plans so that executive incentives align with shareholder interests – and are easily understood.