According to Dr Mark Bussin in his new book Remuneration and Talent there are six trends shaping remuneration for executives.
Please note: Mark Bussin will also be speaking at our upcoming HR Business Partner Conference taking place on 4-5 June 2014 in Johannesburg. He will discuss the evolving role of performance management within an organisation – to learn more about this event, click here now.
Current Trend 1 – Increased scrutiny of performance metrics selection
Compensation committees are more rigorously reviewing their oversight of executive incentive practices (Heim, 2011). The SEC rules and ISS voting guidelines (Say-on- Pay) require that all performance measures and goals be released and compared with actual results for both short- and long-term incentive plans (Reda, 2012).
Current Trend 2 – Introduction of more long-term incentives to encourage ethical behaviour and increase retention
Executive pay does not have a consistent relationship with tenure; however, incentives increase strongly with tenure. The reason for this is that the median, or typical, CEO holds onto most of the equity value generated both through new equity grants and through appreciation in current holdings. Most CEOs’ incentives usually stem largely from holdings of shares and options as opposed to performance- related variation in annual pay (Core and Guay, 2010). Long-term incentives are increasingly being used to encourage ethical behaviour and increase retention. This is not an argument to pay executives more; rather, it is a warning that long-term incentives are not a panacea or insurance policy against unethical or high-risk behaviour.
Current Trend 3 – Fewer “vanilla” share options, more performance-based instruments
There is a clear move away from “plain vanilla” share options or share appreciation rights (SARs) awards. Instead, performance-based awards that vest or pay out only if the executive meets specific performance objectives are being introduced. Performance based awards include incentives such as performance shares, performance-contingent RSUs or restricted shares and share options with performance conditions. Performance based awards in the United States were expected to account for 47% of total executive long-term incentive value in 2011, up from 37% in 2009 (Heim, 2011).
Current Trend 4 – Complex, opaque pay plans are on the decline
A PricewaterhouseCoopers survey (nd, cited in O’Higgins, 2012) found that executives’ value-deferred pay is significantly below its economic value. Deferred rewards, especially when woven into complex, opaque pay plans, deflate motivation and reduce the perceived value of the entire package (O’Higgins, 2012). There is therefore a move to demystify and simplify remuneration packages, making them easy to understand not only for shareholders and investors, but for executives themselves.
Current Trend 5 – The rise of indexed share remuneration
There is now a move toward analysing the relative value of performance and correlating incentives with market factors. In other words, managers and investors should be rewarded only for success beyond what would normally be generated. When a market is booming, it is almost impossible not to make money. In such times, it is argued, compensation should be only for “excess returns” (Desai, 2012). In order to determine what can be considered excess, it is first necessary to establish what a “normal” return for an activity is. This is achieved by evaluating an activity of comparable risk. Indexed share compensation allows executives to receive company shares as compensation, but any returns associated with the broader market or with their industry are subtracted. Share compensation is thus indexed to remove price appreciation arising from market returns. Proponents of indexed share compensation believe that such a mechanism provides an appropriate incentive for high performance and also measures the true incremental value the executive provided (Desai, 2012).
Current Trend 6 – Limits on share-based compensation
A growing body of empirical evidence shows that share based remuneration can lead to earnings management, misreporting, and outright fraudulent behaviour. The primary reason for this is that share-based remuneration may lead executives to invest suboptimally and destroy value to conceal bad news about future growth (Benmelech, Kandel & Veronesi, 2010). A combined compensation package that uses both share-based performance and a cash flow-based bonus is seen to be superior as it induces executives to exert costly effort and reveal any worsening of the investment opportunities.
To learn more about how you can approach these trends within your own organisation and to find out more about Dr Bussin’s new book Remuneration and Talent – click here now.