Board oversight of executive pay: a fresh approach: we suggest a new way forward for board decision making on executive pay tied to company performance--building from the traditional budget-based goals, but also more directly acknowledging the increasing variability in management's budgets.

Author:Rusti, Casandra

Executive pay has long been in the spotlight for shareholders, boards, management teams, and commentators alike. More recently, the connection of executive pay outcomes with company performance has taken center stage. It's been a key focal point in the past, but today the pay-for-performance relationship carries a heightened sense of urgency and a greater degree of precision than ever before. It's become a balancing act across multiple stakeholders, from executives to the broader base of employees, to outside analysts, regulators, and investors.

External stakeholders--investors, regulators, proxy advisors--have the benefit of assessing the pay-for-performance relationship after the fact, when performance has already been delivered and incentives already paid. Yet boards and management teams have the more difficult task of defining expectations and setting performance requirements (i.e., goals) at the outset of a performance period, such that those after-the-fact assessments hold true. Instead, why not allow for judgment after-the-fact for boards and management teams, as well? Not as an excuse for performance below expectations, but as a means of testing the expectations themselves--were they too hard, too soft, or just right ... knowing what actually happened during the performance period?

Variability vs. visibility

Today, many companies face significant variability, both in their end markets and in their operating models. Increasing variability diminishes forward-looking visibility, and the task of setting meaningful goals becomes that much harder. By extension, we see management teams increasing the 'hedge' in their business plans. Most often, these hedges are well intended--to address variability and unknowns, and to feed external guidance. Naturally, boards are cautious with these hedges--careful not to soften expectations too much, being mindful of investor interests and outside scrutiny. From time to time, a real disconnect, and even distrust, can develop between boards and management teams when setting performance requirements for the period ahead.

(Side note: At least to a degree, the rise of relative TSR stems from these observed goal-setting disconnects between the board and management team. First, relative TSR is an easy 'out' for boards that fear their management team maybe sandbagging goals. Second, management teams will sometimes gravitate to relative TSR when forward-looking visibility is low, or where they fear their board...

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