Rewarding Performance, Not Attendance

A CEO’s pay may be one of the most scrutinized numbers in corporate America, but there has always been one lingering question: Is it tied enough to long-term performance?

Slowly but surely, the answer appears to be yes. According to a Korn Ferry Hay Group study of CEO pay at the 300 largest US companies, long-term performance-based pay now makes up 35% of a CEO’s total compensation, up from 27% five years ago. The trend seems poised to continue due to increasing pressure from institutional investors and proxy advisory firms to shift pay away from more immediate salary and bonus increases in favor of long-term performance awards. “Executive compensation has the power to drive or discourage performance, strengthen or undermine corporate culture, and reinforce behaviors, for better or for worse,” says Irv Becker, vice chairman of Korn Ferry Hay Group’s Executive Pay & Governance practice.

CEOs are still well-compensated, even without the performance incentives. A top boss’s base annual salary, at the median, was $1.25 million in 2016. But it now makes up only 13% of median CEO pay, down from more than 17% five years ago. Performance-based long-term incentives for a CEO was, at the median, $4.3 million, and increased about 4.4% over the previous year.

Still, how that performance is measured remains up for debate, as boards and CEOs consider which metrics beyond stock performance work best. There’s some agreement on the quantitative metrics. Total shareholder return is the key metric used by proxy advisory firms, while institutional shareholders also look at return on equity and return on invested capital. Thus, experts say, these benchmarks should be important to boards and CEOs, too.

But governance experts are quick to add that there are other, qualitative measures that can help measure how well the CEO is doing with investing in the firm’s long-term sustainability. These range from the engagement of the employee population, CEO succession efforts, and strategic metrics that will not show up in the short-term financial results.

Each company’s most suitable metrics will be different, depending on the particular facts and circumstances of its business, says Becker. What’s critical is that the design of pay programs aligns with the firm’s business strategy. “Doing so can help a firm avoid overpaying for a CEO,” says Becker.