“It’s not an incentive, just fixed pay in drag” comments may demonstrate a failure of critical analysis

In 2016, we have seen this comment from a proxy adviser repeated by several investors and media outlets during a torrid AGM season where investors have confronted boards on executive incentives for tepid financial results.

It is often accompanied by comments, such as:

“Why is the CEO getting an incentive for doing their day job?”

“Why did the CEO get an incentive for achieving budget?”

“Why should the CEO get an incentive just because there have been no deaths or injuries – that’s what we expect?”

Leaving aside the insensitivity of the said investors and their advisers to the LGBTI community – after all, as long as it is suitable business attire, who cares if it is drag – it would be worthwhile if we get something straight (forgive the pun):

  • if a payment is at-risk, it is not fixed.

Therefore, if there is a probability, however small, of an incentive not being earned, it is not fixed pay.

A discussion of incentive targets is a completely different matter to whether a payment is an incentive or not. Even easy incentive targets have a probability of not being met.

So, the real issue for the investors making these calls was that an incentive target was, in their view, easy. This could well be true, if followed by the words “all else being equal”, or more validly, “given a detailed analysis of total remuneration opportunity and risk”.

We have rarely seen these words (or their ilk) from the investor community, and few companies frame remuneration in these terms in their disclosures.

Pity – because that is the nub of issue. Simply put:

  • more at-risk, more pay;
  • less at-risk, less pay.

How easy or otherwise targets are, is a subsidiary issue. It also depends on the incentive opportunity and the level of fixed pay.

For example, is it better to have,

  • low fixed pay, a high incentive opportunity and easy initial threshold performance requirements for the incentive to start paying out, or
  • high fixed pay, low incentive opportunity and high initial threshold performance requirements before the incentive starts to pay out?

Most shareholders would, if they thought about it, prefer the former. However, we never see this sort of “whole of performance and remuneration” analysis in proxy adviser and investor reports and guidelines.

It is also, coincidentally, an approach that has strong support in behavioural science theory and research (e.g. see studies associated with Vroom’s expectancy theory, and McClelland’s “achievement motivation”). But, as we have mentioned before, evidence-based governance guidelines do not appear to exist (see HERE).

Hence when, proxy advisers, institutional investors and the media ask why are executives getting paid an incentive for doing their day job, check your remuneration report and your engagement discussions – how did you describe the variable pay?

© Guerdon Associates 2020
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