Bloomberg BNA’s Corporate Law & Accountability Report is available on the Corporate Law Resource Center. This news service keeps corporate practitioners informed of legal developments of...
By Yin Wilczek
May 15 — In designing compensation programs, companies should ensure their incentive structures reinforce, rather than undermine, their business strategies, consultants said May 14.
Incentives are a prime opportunity to indicate to employees why the company is choosing to pursue long-term investments over short-term profits or vice versa, said Jim Heim, managing director in the Boston office of Pearl Meyer & Partners. “If you do this right, you can actually find yourself in this positive feedback loop where because employees better understand what they’re trying to accomplish, they’re actually able to accomplish it.”
However, although business strategy usually is pegged to financial indicators, there may be times—such as industry disruptions—when companies must undertake decisions that sacrifice immediate financial results, said Theo Sharp, also a managing director with Boston-based Pearl Meyer.
Heim and Sharp spoke at a webcast sponsored by the National Association of Corporate Directors.
To ensure the company's compensation plan continues to support its overall strategy, even through business and industry changes, the Pearl Meyer consultants suggested a three-step process for designing incentives in which compensation committees annually should:
• evaluate the state of the business, the industry and external forces;
• determine the balance of the prerogatives that drive their companies; and
• adjust their short- and long-term incentives to reflect their priorities.
Explaining the first step, Heim said that because business is in a constant state of flux, companies must periodically assess not only their strategic imperatives, but also their financial imperatives such as generating enough cash to pay their workforce and to fund investments.
In addition, they must evaluate their internal cultural prerogatives, Heim added. “There are certain behaviors you want your incentives to foster and others that are simply unacceptable,” he said. “It's really nice if your incentive plan is in sync with those cultural priorities.”
Sharp suggested that evaluation of corporate culture may be an “underrated piece” when it comes to designing incentives. “Unless the culture will embrace the incentive, I don’t think it’s ever going to work, no matter how well designed it is.”
Moreover, companies must review the state of their industry, including the competitive landscape, the consultants said.
As to external forces, Heim observed that in the era of say-on-pay, public companies must pay attention to the perspectives of the proxy advisors. Institutional Shareholder Services Inc. and Glass, Lewis & Co. LLC have very “specific thoughts” on how compensation plans should be structured, and the advisors will tell institutional investors how to vote based on those thoughts, he said.
Although the advisors' protocols may not work for every organization, a company still must be aware of how it deviates from ISS or Glass Lewis' prescribed approach, Heim said. “The onus will be on you” to convince the shareholders that the company is right and ISS is wrong.
On the second step—determining the balance of the imperatives—Heim noted that prerogatives change depending on what stage a company is in. Young emerging companies generally are not ready to assess their performance strictly in financial measures, given that they can't measure revenue growth until they have revenues, he said. Accordingly, their priorities generally will be strategic in nature.
According to slides provided by Pearl Meyer, there are three stages after the emerging company phase:
• growth companies—where the focus shifts from expanding markets, and there is an even weighting between financial and strategic imperatives;
• mature companies—where the focus shifts to maintenance and financial imperatives take precedence; and
• turnaround or industry disruption—where the focus is on efficiency and responding to a shifting market, where strategic imperatives take center stage.
Sharp noted that most companies will find themselves anywhere in between the different stages. “That’s the reason we suggest that compensation committees at least go through an exercise like this every year when they’re designing their incentives to be sure that something hasn’t shifted slightly one way or the other that will cause them to move up or down the scale,” he said.
Finally, companies should adjust their long-term and short-term incentives in line with how they balance their prerogatives, Heim said. Companies should avoid redundancy and ensure their short-term incentives have a different focus than their long-term incentives, he added.
Heim also noted that over the longer term, most investors and management teams want to see progress on margins and returns on investment, and this should be reflected in the long-term incentives.
Sharp suggested a “simple” shorthand: “It's income statement in the short term, balance sheet in the long term.”
To contact the reporter on this story: Yin Wilczek in Washington at firstname.lastname@example.org
To contact the editor responsible for this story: Ryan Tuck at email@example.com
All Bloomberg BNA treatises are available on standing order, which ensures you will always receive the most current edition of the book or supplement of the title you have ordered from Bloomberg BNA’s book division. As soon as a new supplement or edition is published (usually annually) for a title you’ve previously purchased and requested to be placed on standing order, we’ll ship it to you to review for 30 days without any obligation. During this period, you can either (a) honor the invoice and receive a 5% discount (in addition to any other discounts you may qualify for) off the then-current price of the update, plus shipping and handling or (b) return the book(s), in which case, your invoice will be cancelled upon receipt of the book(s). Call us for a prepaid UPS label for your return. It’s as simple and easy as that. Most importantly, standing orders mean you will never have to worry about the timeliness of the information you’re relying on. And, you may discontinue standing orders at any time by contacting us at 1.800.960.1220 or by sending an email to firstname.lastname@example.org.
Put me on standing order at a 5% discount off list price of all future updates, in addition to any other discounts I may quality for. (Returnable within 30 days.)
Notify me when updates are available (No standing order will be created).
This Bloomberg BNA report is available on standing order, which ensures you will all receive the latest edition. This report is updated annually and we will send you the latest edition once it has been published. By signing up for standing order you will never have to worry about the timeliness of the information you need. And, you may discontinue standing orders at any time by contacting us at 1.800.372.1033, option 5, or by sending us an email to email@example.com.
Put me on standing order
Notify me when new releases are available (no standing order will be created)