A High Risk, High Reward Pay Orientation: Can an aggressive pay-for-performance reorientation help businesses meet goals?

• Author: Charlebois, Stephen
• Position: COMPENSATION MATTERS

A financial services firm with revenues in excess of $1 billion utilized a price-vested options approach with rigorous goals to align with the company's high-growth strategy.

The strategy was successful, and after the stock price nearly doubled by the end of the performance period, the CEO realized values in excess of 10 times what the value was when the options were granted to the executive.

Introducing a "highrisk, high-reward" pay design that allows companies to provide outsized wealth creation opportunities for outsized performance.

This approach is appropriate for companies in varying contexts, whether in a distressed industry (e.g., oil and gas, retail), a turnaround situation, a private equity-backed high-growth firm, or just a firm with the goal of making pay for performance more prominent within the organization. Or perhaps reportable pay is too high. If so, a "high-risk, high-reward" plan can help cut the reportable grant date fair value of pay while offering an aggressive incentive to executives when performance is delivered longer-term.

Take, for example, the exploration and production sub-industry of the oil and gas sector. "Lower-for-longer" crude prices have forced a reassessment of pay levels to meet both proxy advisor and shareholder demands. How do you revitalize executive incentives in this context? Devise a plan to cut reportable pay while offering a significant upside to executives if performance goals are met; all the while maintaining a largely performance-based plan in the eyes of external stakeholders.

Consider three temporary approaches, employed separately or in combination, which can ease the pay squeeze that executives might otherwise feel.

Figure 1. Reduce the grant date fair value of performance shares. Do so by decreasing the target while increasing the maximum payout. This is a simple tweak for companies already granting performance shares. Depending on Monte-Carlo valuation inputs (if using market-based measures), reportable pay can decline while preserving a performance-based design as measured by proxy advisors.

Figure 2. Introduce performance options. Leverage the opportunity for wealth creation tied to share price by...