The Advisors' Blog

I previously blogged about how companies are looking to increase workforce compensation due to inflation & talent wars. But of course, compensation committees also need to look at inflation in the context of setting executive pay. An NACD blog flags that merit budgets/salary increases and incentive plan goal-setting may be two specific areas that compensation committees need to consider in this inflationary economy. Here’s a short excerpt of the issues:

-Because the current environment is challenged by inflation, as well as ongoing pandemic and labor difficulties, some management teams might see an increase to the merit budget for the broad workforce as perhaps one of the easier decisions to make this year. It’s a different story, however, for executives. Boards have generally been more willing to increase incentive opportunities than to provide executives with significant salary increases. This is due to the bias toward performance-based compensation and can be seen in the evolution of executives’ pay mix over the past 40 years. However, incentive plans can be perceived as riskier during inflationary times—to say nothing of the other risks looming—and so higher incentive opportunities may be less valued right now than smaller salary increases.

– [A]t the board level, we need to at least understand the subtleties [of inflationary effects and price changes through the company’s supply chain] to develop a feel for whether any changes might be warranted to, for example, thresholds, maximums, or gatekeeper measures in any existing or future incentive plan. This is important when determining and explaining any non-GAAP (generally accepted accounting principles) or judgmental adjustments to payouts… A complicating factor for directors approving annual goals is that inflation generally results in higher earnings growth than we normally see….If demand stays strong as inflation increases, you may see companies overachieve during the early days of a cycle. Then, the opposite occurs as inflation cools, and taking earnings expectations back down to pre-inflation ranges becomes similarly difficult, especially for investors.

The blog then recommends that compensation committees consider providing potential year-end adjustments for actual vs. projected budget assumptions, or increasing the range from threshold to maximum.

– Emily Sacks-Wilner