February 1, 2024
Practical Considerations for Simplifying Compensation Programs
Back in October, Liz blogged about a report from non-profit FCLTGlobal making the case for the “simplest” solution to what some investors consider the overcomplication of executive pay programs. That solution is, according to the non-profit, “direct stock ownership by executives, with long-term holding periods.”
The notion of doing away with performance programs isn’t new, especially in Europe, and Liz’s blog identified Norges Bank as one investor that continues to push for simplified pay. But Norges is not alone. In 2019, CII overhauled its executive compensation policy and urged companies to reduce the complexity of their incentive plans.
Although it’s leading to a fair number of against votes by Norges, this can all seem somewhat… theoretical… for many companies. But this report just released by the Center On Executive Compensation (a division of HR Policy Association) addresses practical considerations for pay simplification and gives an example. Here’s an excerpt regarding Unilever:
Under the revised approach to incentives, executives were encouraged to invest up to 100% of their annual incentive payouts in Unilever shares. The company matched the participants’ investment based on the performance of the company. The amount of the company match ranged from 0% to 200% of the participants’ share investment and vested over a 4-year period.
Why do that? The stated rationale for this change was to simplify rewards; increase shareholding levels throughout Unilever’s management population; ensure consistent alignment of performance measures with strategy; and increase the timeframe over which incentives are delivered. Since the time period over which the incentive is earned matched the time period of the reported performance results, it was easier to communicate to executives. Further, a co-investment approach ensures the executive risks his or her own money in company shares, creating real alignment with shareholders. […]
Drawing on research from behavioral economics, one might expect the incentive effect of investing an executive’s own money to be increased effort to create shareholder value and avoid loss. This research suggests that individuals are more highly motivated to avoid losses than to seek gains, suggesting the co-investment model may help create sustained shareholder value while avoiding excessive risk.
The report notes that simplification isn’t for everyone. “[I]t is important that companies engage with investors to understand the extent to which complexity is truly the driver of concerns over the current structure of long-term incentives, if the underlying motivation for simplification is an effort to rein in pay rather than reduce complexity, or whether investors have multiple objections to current executive compensation designs.” It includes a list of key questions the committee should ask when considering simplification and some examples of alternative approaches for committees that want to explore them.
– Meredith Ervine