The Advisors' Blog

Here are a couple of commonly held beliefs on executive pay:

1. Performance-based pay – linked to total shareholder return or other financial metrics – will help executives focus on delivering profits to investors.

2. Investors need a lot of information to assess whether that’s happening to their liking.

Despite all of our hard work on these two topics, executive pay continues to increase, and in some cases ascend into the into the stratosphere. A lot of people – including CEOs! – think it’s gone too far and have suggested pay caps. With all that head-scratching, maybe we should also consider whether “say-on-pay” and “pay versus performance” – and the complex executive pay programs that they spotlight – are part of the problem.

A recent 31-page report from Boston-based non-profit FCLTGlobal makes the case that commonly used pay metrics tend to incentivize short-term results at the expense of long-term performance. Here’s an excerpt:

The most effective remuneration structures are matched to a company’s objectives, strategy, and management. The simplest solution is direct stock ownership by executives, with long-term holding periods. This arrangement is similar to private equity-backed companies’ structures, where the focus is on executive wealth creation over time. This report offers practical tools to aid corporate boards in designing executive remuneration, calibrating long-term equity awards, and effectively communicating remuneration policies to shareholders. These actions include the following:

• Replacing approaches that are counterproductive in the long term, and focusing on rapidly building executive share ownership through restricted stock and share retention policies

• Applying alternative indicators to gauge compensation structure and incentives

• Streamlining corporate disclosure of pay practices, emphasizing the decision-making narrative Investors require simplified approaches to say-on-pay voting that are aligned with long-term remuneration design.

We propose a framework that focuses on five key elements: holding period, quality, targets, instruments, and progress, each of which is broken down into key elements that investors can use to update their proxy voting policies. This is a critical step to take: by clearly stating in writing what criteria are likely to lead to a no or yes vote, investors can lean into a set of principles that drive proxy voting and contribute to positive change at portfolio companies.

The report also says AI could play a role in next-gen executive pay:

We expect that over time, digital technologies like artificial intelligence will revolutionize the process of gathering remuneration data for proxy voting. Tools like pay duration and wealth sensitivity, which we present in this report, have complex data needs. But they need not be so complicated, given currently available technologies. The proxy agencies, who hold significant sway in proxy voting outcomes, could embrace these technologies to help broaden the tools available to companies and investors alike.

FCLT – which stands for “focus capital on the long-term” – also delves into company & investor frustrations with say-on-pay, the shortcomings of TSR as a pay metric, and actions for boards of directors. At the back, there’s a chart with “do’s & don’ts” for improving long-term alignment.

The notion of doing away with performance programs isn’t a new one, especially in Europe. I most recently blogged about it in August, when Norges Bank continued its push for simplified pay structures. This year, Norges voted against say-on-pay at companies that were “most materially misaligned” with the firm’s preferred approach – which worked out to 1 in 10! That said, US investors have been reaping returns right along with executives these past few years. So, there’s probably not consensus on whether US executive pay is “broken” enough to fix.

– Liz Dunshee