ISS vs. Nucor's ghost: Lost in metric madness: the extraordinarily effective compensation plan once embraced by this company and its legendary CEO, Ken Iverson, is worthy of widespread emulation. What a shame that it would now get snagged by a set of arbitrary standards that actually harm shareholders.

• Author: Hodak, Marc

If there were a "Top 10" list for best man-agement incentive plans ever, the Nucor plan created in 1966 for the senior officers of this steel company would certainly rank near the top. Over the next 30 years, CEO Ken Iverson and his Nucor team would create one of the legendary stories of American business. Everyone who wrote their story, including Iverson, singled out Nucor's incentive plan as a cornerstone of their success.

By today's standards, Nucor's old compensation program looks oddly primitive. It consisted of just three elements: a cash salary, an annual grant of stock options, and a bonus consisting of a fixed share of profit above a threshold return--what we would today call an economic profit or EVA-style plan. Each year, the threshold return would automatically ratchet up, based on the firm's growth and their prior achievement. Incentive awards were paid 40% in cash and 60% in stock.

That was it. No perks. No bulletproof, supplemental retirement plans. Nothing that wasn't available to the rest of Nucor's rank and file. The incentive plan at the heart of this program remained essentially unchanged for over three decades, which turned out to be an unexpected source of its power; the longer this plan remained intact, the more it reinforced management's value-creating behavior.

All of this background leads to the following question: If you were tempted to implement a similar compensation program today, why should you have to risk the wrath of ISS? (This is not meant to pick solely on ISS. Glass-Lewis, GMI and other compensation governance watchdogs have similar standards to those critiqued here. ISS is highlighted simply because they are the largest and most influential proxy adviser, and they are relatively transparent regarding their standards.)

Caps on performance

There are many reasons to be concerned about ISS's response. For example, Nucor's bonus plan had no caps. According to ISS, "Best practices suggest companies disclose bonus caps for CEOs that are tied to a fixed and/or disclosed value such as base salary." But anyone who has worked in a regime with pay caps knows that a cap on pay can be tantamount to a cap on performance. They have seen colleagues climb over the cap and, finding themselves on a plateau of unrewarded performance, their exertions--and company performance--magically level off for the remainder of the performance period.

Nucor's strategy included diligently building its manufacturing capabilities during recessions in advance of an eventual recovery. When they once again found the winds at their backs, they would not stop, or even pause, when their bonuses hit "two-times target" or some other artificial barrier that didn't exist for them. The more they produced, the more everyone earned, and their shareholders were immensely grateful.

Proxy advisers like bonus caps because their standards are largely focused on controlling compensation costs, and capping bonuses is a ham-handed way of doing so. However, if one is concerned with motivation as well as cost--and proxy advisors at least purport to care about alignment--then the appropriate way of controlling compensation cost is to moderate the rate at which pay increases with performance, called pay leverage. Unfortunately, none of the proxy advisers distinguish, let alone track...