How Will Compensation Programs Shift In 2021?

A new report suggests that executive pay programs are misaligned with the company’s purpose and drivers of long-term success. Some takeaways.

We can all agree that 2020 brought a seismic shift to virtually all aspects of our lives, from health and safety concerns to uncertain economic futures for individuals and organizations alike.

As we try to put this difficult year behind us and forge into 2021, it is imperative that corporate leaders focus on an economic recovery that benefits all levels of employees and has a focus beyond simply profits.

A new report by Korn Ferry and the Aspen Institute suggests that many executive pay programs are actually misaligned with the company’s purpose and drivers of long-term success.

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Today, most executive pay programs are firmly aligned with total shareholder return (TSR) as the center of their performance measurement universe. However, we are seeing a slow but noticeable shift. A recent Korn Ferry analysis of proxy statements of 150 large U.S.-based companies found that approximately 20 percent now have some form of purpose-driven strategic objectives, including ESG measures (environmental, social, corporate governance) as key performance metrics for executive pay.

Key questions Compensation Committees should consider when working to align compensation with organizational goals and purpose:

• Have the Board and management discussed, confirmed, and communicated to all key constituents the company’s annual, medium-term, and long-term objectives?

• Are the links between executive compensation and the company’s mission, vision, values and culture evaluated and reconfirmed each year?

• Has the Board established clear guidelines for determining which metrics of performance require compensation beyond base salary?

• Are the metrics and performance standards in incentive plans designed with the company’s stated purpose and business objectives in mind?

• Is the rationale for equity grants and any associated performance conditions articulated?

• Are the key non-financial drivers of value given sufficient weight when determining awards?

Another key consideration in creating effective executive compensation programs is fairness.

Companies must temper their sharp focus on external benchmarking and allowing it to dictate executive pay outcomes. There needs to be a more holistic view of compensation, one that considers internal pay relationships and ensures that rewards and economics are shared appropriately across an organization.

When considering fairness, Compensation Committees should address the following:

• Has the Board and executive team assessed the reasonableness of the pay relationship between the CEO and his/her direct reports, and relative to all other levels of employees?

• Has the Board considered the appropriate basis for sharing company profits between the company and its shareholders?

• Has the Board thoroughly evaluated and approved the financial impact of its executive pay obligations in the event of executive terminations, for any reason?

• Has the Board adopted useable and adequate clawback provisions to protect the company in the event of executive misconduct or malfeasance?

• Do the results of the decisions appropriately reflect the company’s values?

A third recommendation involves using credible goals in incentive plans with difficult-to-manipulate outcomes.

Goals should be achievable and clearly aligned with core strategic priorities. However, the financial rewards for achieving/exceeding targets should not encourage excessively risky behavior. In addition, incentives should include a meaningful financial downside for under-performance.

Key questions to consider:

• Are incentive plan metrics consistent with and clearly linked to business strategy?

• Do incentive metrics and goals adequately balance short-, medium-, and long-term business priorities?

• Has the Board carefully considered the behavioral risks inherent in aggressive goals?

• Have goals been “stress-tested” to assess difficulty and probability of achievement?

• Has the Board implemented adequate guardrails and monitoring mechanisms to mitigate behavioral risks?

• Has the Board evaluated whether the incentives for executives in charge of risk, compliance and audit functions are suitably structured for these job functions?

This is an unprecedented period of change in the world. There are many factors and forces combining to place increased pressure on leaders to step up and lead in ways they may not have been used to leading before. Rewards decisions must be made in different and unfamiliar contexts. The decisions we make now and in the coming few months and years will be critically important. They will make statements, intended or otherwise, about what we stand for and what we value. The best advice is to be deliberate and clear about what you value, and then make bold decisions that are clearly consistent and well aligned with those values.