Compensation committees are expected to have their hands full in 2024 amid economic changes and ongoing geopolitical uncertainty, according to experts at Pay Governance LLC.
These committees will make key corporate decisions amid close scrutiny from shareholders and proxy advisory firms interested in how executive pay is linked to performance, among other topics.
In-house counsel can expect to be called upon to offer advice about the legal and regulatory issues in play, including the Securities and Exchange Commission’s pay versus performance disclosure rules.
Incentive plan performance ranges, performance periods and the use of discretion in long-term incentive payouts are among the pressing issues compensation panels are expected to address.
“Compensation committees will need to devote greater attention in the coming months to ensure their companies’ executive compensation programs continue to attract, retain, and motivate talent while maintaining alignment with shareholder expectations in a challenging environment,” write partners from Pay Governance LLC in a Harvard Law School Forum on Corporate Governance blog post.
Compensation committees are expected to spend time reevaluating the ranges for target performance levels to determine if minimum and maximum levels need to be changed, according to the Pay Governance partners.
The advantage to establishing a wider performance range is it reduces the likelihood of a zero payout if performance falls short and minimizes the chances of a very large payout if overly conservative targets were set.
Additionally, compensation committees are advised that setting lower performance targets than the prior year’s actual results could attract undesired attention unless a clear justification is offered.
“The challenge facing compensation committees anticipating a downturn in performance is the need to strike the right balance between rigorous yet achievable performance goals with shareholder sensitivity over potentially paying higher incentives for lower actual performance,” the blog post said.
The Pay Governance partners said that compensation committees, as well as management teams, can find it difficult to create reliable three-year performance targets that shareholders and proxy advisory firms prefer.
In response, some companies have implemented the use of three one-year goals within the three-year performance period.
“The use of three 1-year goals allows companies to establish more reliable performance goals that are set and measured over a shorter (and presumably more predictable) timeframe,” the partners wrote. “Goals can be set at the beginning of each year permitting one-third of the award to be earned and banked until the completion of the three-year performance cycle.”
The inclusion of a total shareholder return modifier can also help prevent criticism that annual performance goals are being used to determine long-term incentive payouts, they said.
Use of discretion
Compensation panels should also weigh carefully whether to use discretion to increase formulaic payouts under long-term incentive plans.
The Pay Governance partners highlighted that companies which upped payouts during the COVID-19 pandemic generated “a fierce backlash by investors and the proxy advisory firms.”
“Unfortunately, the COVID-19 fallout has also tainted the responsible use of discretion in annual incentive plans that carve out 20% to 30% of the target incentive for strategic or non-financial performance goals,” they wrote.
However, the partners noted that the use of judgment to assess performance is often required, so compensation committees should be wary of doing away with any form of discretion.
“The key to successful use of discretion is compelling disclosure of the factors that led to the performance evaluation and payout decision,” they wrote.