Setting 2021's Compensation Goals in the Wake of COVID: Boards are used to working with uncertainty in setting incentive goals, but 2021 is forcing them to raise their game.

• Author: Jones, Blair
• Position: COMPENSATION MATTERS

Setting goals for incentive compensation has long been one of the compensation committee's biggest responsibilities. This task is especially difficult with the continuing uncertainty of the COVID-19 pandemic and corporate commitments to serving all stakeholders, not just shareholders. To add to the complexity, some business sectors are thriving while others face a very uncertain recovery.

Compensation committees are asking:

* What will good performance look like in 2021?

* Will management know enough at the beginning of the year to set reasonable goals?

* How volatile might performance outcomes be?

* What level of discretion might be appropriate to reserve for year-end?

* Will it be "safe" to set longer-term goals?

* For companies temporarily boosted by the pandemic, is it appropriate to set 2021s goals below 2020's results?

* How should incentive plan payouts consider the impact on all stakeholders?

While many of the same goal-setting considerations that apply in any year are still relevant, most boards will need new strategies. The application of these strategies will necessarily vary by industry.

Principles of effective goal setting

Goal setting has always been a balancing act. The aim is to motivate management while keeping payouts in line with results delivered to shareholders. This year, compensation committees must work through the deep uncertainty about the course of the pandemic. Increasingly, boards are weighing the needs of other stakeholders based on input from institutional investors.

In the past, many companies relied on standard principles for goal setting:

* Growth requirements from the prior year.

* Fixed ranges of threshold and maximum performance relative to target (e.g., +/-10% or 20% from budget).

* Long-term growth expectations (e.g., 8% EPS growth rate per year).

* Expectations about the likelihood of achieving certain payouts (e.g., threshold exceeded with 90% probability, maximum achieved with 10% probability).

Since these traditional inputs will not be relevant for many companies in 2021, here are additional perspectives and inputs for setting financial goals:

* Sensitivity testing to understand the performance required on underlying drivers of the incentive plan metrics (see figure 1, for a retail example). This analysis includes events that might play out over the course of the year and their potential impact on goal achievement. It helps boards understand the range of potential outcomes.

* External expectations...