Short-term incentives motivate short-term behavior. Corporate boards can drive long-term performance by making changes to remuneration that encourage long-term behavior by executives while avoiding common pitfalls. Similarly, investors can support long-term executive remuneration plans through their votes and engagement. Financial incentives motivate behavior—indeed, financial incentives may work too well. Executive pay is focused on a short time horizon—with recent data pegging average duration of executive compensation plans for CEOs of MSCI All Country World Index (ACWI) constituents at 1.7 years. This short-term focus can have far-reaching consequences, yet setting out to make remuneration longer-term is no simple task.

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Both investors and corporate directors strongly believe in the importance of using performance-linked pay. At the same time, the long-term effect on executives’ behavior and companies’ performance remains rooted in theory rather than evidence. Behavioral studies find that performance-linked pay motivates people effectively only for routine tasks— and a CEO’s job is anything but routine. This suggests performance-linked pay is not an easy solution to executive remuneration. And pay linked to the wrong metrics simply compounds the problem.

The most effective remuneration structures are tailored to a company’s objectives, strategy, and management. Careful tailoring of long-term remuneration packages involves directors—and their shareholders—taking multiple steps over time. This report offers practical tools to aid in taking those critical steps, providing standardized frameworks for communicating, evaluating, and designing long-term pay plans.

Remuneration design should be tailored, but investors cannot evaluate every portfolio company’s remuneration plan in isolation, and remuneration committee directors cannot ask the marketplace— regulators, proxy voting advisers, and executive candidates themselves—to treat their plan as fully bespoke. FCLTGlobal’s tools aim to help define long-term executive remuneration at scale.

Our tools empower companies to replace some commonly used elements today, reflect on their long-term needs, and effectively tailor long-term remuneration to corporate strategy. By replacing remuneration provisions that drive short-term behavior—like creating large one-off moments of financial reward, accelerating vesting schedules upon departure, relying on peer groups to determine pay structure, and trying to motivate executives exclusively through their pay plans—companies have the opportunity today to take a first step towards implementing longer-term remuneration plan design.

Directors and investors can then use key questions to understand the firm’s circumstances, evaluate the relationship with remuneration design, and find options for focusing remuneration on long-term value. Questions like “How long is the firm’s business cycle?” “How wide is the firm’s range of potential outcomes relative to expectations?” and “What is the firm’s ability and willingness to pay executives over time?” help determine the parameters for plan design. Remuneration plans can then be redesigned using four key decisions focused on the degree of performance linkage, instruments of pay (e.g., cash, stock, options, etc.), targeted time horizon, and use of mandatory holding levels (as either a multiple of pay, percentage ownership in the firm, or proportion of an individual’s net worth).

Designing a pay plan unconstrained by existing contract provisions occurs infrequently, usually during leadership transitions or corporate actions. Outside of those strategic moments, corporate remuneration committees can use these tools to evaluate and manage the long-term strengths and weaknesses of their existing plans. Investors can do the same, evaluating a plan prior to a remuneration-themed corporate engagement. For both companies and investors, clarity on remuneration structure is critical, and we would encourage communication in this more long-term format in the Compensation Disclosure and Analysis sections of proxy statements.

This research was conducted with full appreciation of the fact that pay structure is just one of the many issues that prevent equitable and strategic remuneration today. Beyond the structure of executive pay plans, there are considerable issues with the metrics used to determine rewards and the amount of money being paid to executives. While this research tackles pay structure as a singular issue, it is just one piece of a much larger puzzle. The job of the remuneration committee is to ensure that pay is structured strategically, calculated appropriately, and dispersed fairly, and therefore becomes a tool to achieve long-term goals.

Toolkits for Long-term Executive Remuneration

Governance, Incentive Alignment | Toolkit

Tools for Long-term Executive Remuneration

8 March 2021 - These tools empower companies to tailor long-term remuneration by replacing some elements now, reflecting on their long-term needs, and finally by using key decisions to redesign pay packages

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Incentive Alignment | Article

Study From BU Reevaluates Executive Compensation

23 September 2019 - “You get what you pay for.” When it comes to executive pay, the old adage holds true. Companies’ compensation committees typically evaluate their CEOs, like any employee, based on performance benchmarks, and like every employee CEOs...

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Incentive Alignment | Article

The Long-term Impact of Corporate Compensation Models

28 July 2020 - FCLTGlobal will research new ways in which short-term, status-quo compensation practices can be restructured to enhance long-term value creation.

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