By Mark Emanuel
In recent months, institutional investors have taken aim at the pervasiveness of short-termism and implored companies to better communicate their strategic framework for sustained, long-term value creation. And, while the root causes for short-termism are varied and complex, the role of executive compensation often features prominently in the debate. So what’s a company to do to ensure its pay programs discourage short-termism?
First and foremost, avoid an “all eggs in one basket” approach, which overemphasizes a singular result, often over a single year. Using complementary metrics ensures that top-line, bottom-line, return, operational and strategic measures all get appropriate weight and focus.
Companies should also reconsider the role of stock options (as one in a portfolio of vehicles) to provide a longer-term orientation to pay. In the past, long-term incentives were primarily delivered as options with seven- or 10-year terms. But, today, options have largely been replaced by performance plans with incentive horizons of only three years—hardly long-term.
Meaningful and sustained stock ownership is one of the most effective means to align long-term executive and shareholder interests. While an ownership ethic starts with the “tone at the top,” several structural elements can reinforce this ideal. First, go beyond the standard five- to six-times salary ownership guideline for CEOs (and three-times salary for other NEOs). Second, reevaluate what holdings count toward the guideline—unexercised options or unvested shares, for example, can “water down” the requirement. Finally, extend vesting and performance periods beyond the traditional three or four years, and consider “hold-to-retirement” (or even “hold-into-retirement”) provisions.
Share buybacks are front and center in the debate about short-termism and executive pay. And it’s no surprise given the popularity of earnings per share as an incentive metric. The challenge? Ensure the debate around buybacks focuses on capital deployment strategy, and not compensation. To this end:
Each of these tools can be readily implemented in a variety of settings. By seeking balance in program design, fostering a culture and ethic of stock ownership and mitigating the potential that buybacks can become a lever to game incentive outcomes, companies will be better prepared to discourage short-termism in their executive pay programs.
Mark Emanuel is a Principal with executive compensation consulting firm Semler Brossy (semlerbrossy.com). Mr. Emanuel can be contacted at memanuel@semlerbrossy.com.