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Executive Compensation Based on Performance

The issue of pegging executive compensation to some metric of performance is continuously debated by CEOs, board members and shareholders alike.  While a 2016 survey on CEO compensation[1] reflects that the majority of CEOs and board members agree that pay can be appropriately linked to CEO performance, not everyone is on board with this assessment, and not all CEOs and board members agree on the specific metrics that should be used to link pay and performance.

The New York Times[2] had an interesting editorial on the topic of high executive pay on July 14, 2016.  The editorial addressed the link between executive pay and a company’s stock price, citing a new study calling for the reform of executive pay practices in an attempt to cut costs on behalf of company shareholders. A similar sentiment was raised by the Harvard Business Review[3] on February 23, 2016, which argued for the termination of executive pay based on performance. 

As the company’s CEO, you may be required to meet financial, non-financial or market based goals.  The link between these goals and your compensation needs to be spelled out — often by your executive compensation attorney during negotiations — in your contract or in a written company policy.  There are pros and cons on both sides of the issue including:

Pros:
  • Recruitment:  An effective pay for performance program can act as a recruitment tool to attract successful CEOs and other professionals.
  • Goals:  Linking intrinsic motivation with external rewards may assist in reaching corporate goals. 
  • Clarity and Specificity:  If embodied in an executive contract or a written company policy, there is a deliberate metric for an executive to reap the rewards of the success of her efforts.  It can also ameliorate shareholder complaints about the large rewards given to underperforming executives.
Cons:
  • Motivation:  Many CEOs such as yourself say that they already give 100% effort to their respective companies regardless of incentives.  With that sentiment as the backdrop, it is unclear if linking executive compensation to performance is truly an effective motivator. 
  • Group Effort:  Depending on the specific metrics established by the board, incentives linked to group performance can lead to conflict within the group rather than effective collaboration.  
  • Nonmonetary Incentives:  Nonmonetary incentives, such as work schedule flexibility, paid time-off and telecommuting options, may provide greater motivation to CEOs/CFOs.

As experienced executive compensation and employment attorneys, we generally approve of these “pay for performance” incentives as long as we have had an opportunity to understand them and make sure that they are drafted with sufficient strength and clarity to protect our valued executive clients.

References
[1]Rock Center for Corporation Governance of Stanford University

[2] The New York Times

[3]Harvard Business Review

About the Author

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George Birnbaum

Since 1980, sophisticated business people have relied on George to apply the meticulous preparation, attention to detail, and devotion to his clients he learned from fabled trial lawyer Louis Nizer. A graduate of Harvard College and Harvard Law School, George has over 35 years of distinguished deal-making, litigation, mediation and arbitration experience which he has used to negotiate high-stakes agreements for senior executives and select business clients throughout the United States.