In a recently released statement, Mercer HR Consulting outlined what its executive compensation consultants see as the trends most likely to shape how executive compensation programs are designed and pay decisions are made in 2008 and beyond:
Pay for performance gets the spotlight. All of the factors shaping this proxy season are converging in one important arena – paying for performance. Shareholders want it, the SEC wants companies to disclose specific measures and targets, and companies are looking closely at how performance could be affected by an unpredictable economic environment. We expect to see ”disconnects“ – where awards based on 2007 performance are reported in 2008, a time of depressed share prices and perhaps poor Q1 earnings and revenue reports. Companies will have a difficult time getting their pay for performance story heard.
Goal setting and performance measures revisited in an economic downturn. Uneasy with the volatility of the market, companies are taking a hard look at the drivers of real long-term economic value, reassessing their performance metrics and realigning their variable compensation with financial, strategic and operational measures, as opposed to more traditionally used metrics such as “earnings”. But with so much uncertainty created by the financial market crisis, companies are struggling – more so than ever – with setting credible goals. While some companies can use a relative approach (tied to the performance of an external index or industry group), they need to be prepared to pay, and possibly pay well, for negative absolute performance.
Continued changes in long-term incentive strategy. Surprisingly, the pace of change in the long-term incentive arena doesn’t seem to have slowed. The experimentation with a mix of equity vehicles continues as companies add vehicles or change the allocation among options, restricted stock, performance-based equity and even cash. Some companies have looked at an uncertain economic future and made the decision to reduce or even eliminate performance-based equity until the economy stabilizes.
Reemergence of stock option repricing. Changes in stock price put stress on equity compensation programs, particularly those relying on options. Some companies are examining whether there is a compelling rationale for repricing stock options for all holders, not just executives. The new twist on this old strategy is that now it requires shareholder approval. It remains to be seen whether shareholders will acquiesce at a time when their returns are down.
Market fragmentation: A shift away from “typical” practice. As companies focus on implementing compensation programs tailored to their individual strategies, culture and priorities, we no longer see a “typical” compensation structure employed by the majority of companies – even within an industry group. Even the tech sector, where options were once the only equity vehicle used, now displays a wide array of approaches, using cash and a variety of equity vehicles. Larger companies were the first to break from this norm, but smaller and mid-size companies are quickly following suit.
Shareholder optics has an impact. In light of increased disclosure requirements for greater transparency and specificity, companies are re-examining their total executive rewards. The result: Compensation targeted to the 50th rather than the 75th percentile, more rigor around establishing peer groups for comparing market practices, increased use of clawback, anti-hedging and other policies intended to protect shareholders, and decreased use of perquisites and benefits. Further, the increased pace of executive turnover has had the unintended consequence of affording boards the opportunity to revisit and reshape the terms of employment, including change of control and severance arrangements.
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