Has pay for performance reached a tipping point?

by Cydney Posner

Are companies starting to take pay for performance more seriously?  That’s the conclusion drawn in this article from CFO.com that reports on a study by comp consultant Aon Hewitt.  While the trend has been prominently discussed for several years, “the depth of that trend may have been overblown.” It’s not that companies have only been paying lip service to the concept, but 2014 may prove to be the tipping point: “It’s 2014 that is proving to be the year when pay for performance is settling in once and for all as an overriding theme in executive pay….” An Aon  consultant suggests that the impetus may have been the “increasing, heavy pressure from activist shareholders and shareholder advisory firms. They’re saying, ‘If you’re paying at the 75th percentile within a peer group or industry, you ought to be around that neighborhood of performance.’ ” 

The article observes that “[m]ore compensation committees are asking for that kind of analysis for year-end reviews of compensation vs. performance on goals. More audit committees are focusing on executive pay as part of their risk-assessment function. And from a more outwardly visible standpoint, companies are going to greater lengths than ever to make the case for their pay plans in their annual proxy statements. ‘[CD&A] is moving from a compliance document, checking off all the boxes for the information you have to provide, to a real sales document that tries to provide a full context for the executive-compensation program’ [according to the Aon consultant]. ”

Aon Hewitt surveyed one executive and one director from each of 294 participating companies. The top comp issue identified by both groups was pay competitiveness.  (Of course, pay competitiveness is determined largely by benchmarking, a technique that many suggest has been used to ratchet up executive compensation as executives were being paid at levels that matched or exceeded executives at peer group companies.) Pay for performance was the second most important issue for directors, while, “for executives, incentive payout opportunities and performance goal setting were the second- and third-greatest concerns.”  Apparently, executives in the survey expressed concerns that they were being asked to do more for less.  The article reports that companies are increasingly awarding forms of equity that include performance criteria.  In addition, thresholds for short-term incentives have also been rising.  In the past, short-term incentive payouts were triggered upon the achievement of 85% of a performance target, but now more companies are raising the threshold to 90% or 95%:  according to the consultant at Aon, “’Think about the target going up every year…. ‘It’s, ‘We expect you to grow the business 8%, and we’re also tightening the band under which you get an incentive payout.’ That’s a clear emphasis on pay for performance.’’  Moreover, the emphasis has shifted away from short-term incentives toward long-term incentives, now typically representing 60% to 65% of pay, the theory being that long-term incentives motivate executives to focus their efforts on positioning the company for long-term success.

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