Are annual performance-based incentives the “new black”?

by Cydney Posner

As reported in this article in the WSJ, Mercer has released a new study of CEO compensation.  The key results: “95% of S&P 500 company chief executives earned a short-term incentive payout in 2013, and the median incentive payout was 115%.”  For a Mercer executive, the data raise questions about whether targets are set at appropriate levels. The data also lead to speculation about whether these annual incentives are just an unintended consequence of the law limiting the tax deductibility of non-performance-based pay above $1 million.  That is, are these “performance-based” annual incentives with apparently easily achieved targets just substitutes for salary that circumvent the tax law cap – are annual performance incentives just “the new black”?

The Mercer executive suggests that the tax law may be one reason, if not the only reason, as, in his view, “’companies have been trying to keep a hard line on salary increases.’” But why was the median payout well over target? The article contends that “[i]f the intention really is to give CEOs an incentive to perform, rather than just pay them a guaranteed amount under another name than ‘salary’ in order to minimize tax, boards may need to take a closer look at what they are rewarding and why.”  According to the Mercer executive, the problem may lie in “herd mentality and information asymmetry. Companies, he said, often adopt incentives they see peer companies using, instead of developing incentives that make sense for their own company and its actual needs. Moreover, boards may not be expert in the industry, and rely excessively on management to keep them informed. ‘This is not an unbiased process,’ he observed.”

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