Could the Long-Term Incentive Plan Become Extinct?

Although debate raging in Britain about the future of long-term incentive payments hasn’t really caught fire in the U.S., it could nevertheless herald a major shift in the way CEOs around the globe get paid.

Rising public concerns about income inequality worldwide have prompted Britain’s conservative government to probe remuneration practices there. If the country makes significant changes, it will set a new corporate governance benchmark for other countries, fund managers and proxy advisors to take under consideration.

An advisory committee set up by Prime Minister Theresa May has just handed down a report recommending that long-term incentives be scrapped altogether. Instead, it said, executives should perhaps be issued deferred stock options as part of their salary that aren’t at all attached to performance.

The reaction to the recommendation has been mixed. Pay consultancy Mercer called for a less prescriptive approach, arguing that long-term incentives can still drive performance, so long as packages are based on the “right” indicators.

“Relevant ideas are now gaining sufficient traction that every remuneration committee should be asking whether their company should be considering volunteering some changes.”

“Many companies use long-term incentives effectively, so a blanket ban would be counter-productive,” Mercer partner Gordon Clark said.

Detractors argue long-term incentives have become too bloated and too complex to link pay to performance. Assessment metrics have extended beyond pure share-price movements to benchmarks involving industry averages and external factors beyond management’s control. One witness told the British advisory committee that pay was now so complex, executives themselves didn’t always understand their own remuneration.

There also are concerns that long-term incentive payments can be used to avoid publishing a clear and easily-understood headline pay figure—a point acknowledged by Phillip Hammond, the chairman of drug giant GlaxoSmithKline. “We have, to some extent, dressed up what we are really paying people through these incentive structures,” he said.

Donald Trump, while on the campaign trail, criticized the high amounts paid to some large public company executives, describing them as “disgraceful” and a “joke”. He also has pledged to lighten, rather than tighten, regulations, and recently ordered a review of Obama administration rules forcing companies to disclose the pay ratio between CEOs and average employees.

Pressure on U.S. companies can come from other places, though. Norway’s sovereign wealth fund, the world’s largest, this month called on long-term incentive payments to be reined in. And at least one legal expert is urging companies, at least in Britain, to get ahead of the curve.

“Whether the government takes up some or all of these proposals, the relevant ideas are now gaining sufficient traction that every remuneration committee should be asking whether their company should be considering volunteering some changes,” Nicholas Stretch, a partner at CMS Cameron McKenna, told the Chartered Institute of Personnel and Development.

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