Upper Saddle River, N.J. - July 2004
A growing trend in the design of compensation programs, particularly for executives, is to tie their potential rewards directly to the achievement of pre-established, aggressive performance objectives. This is consistent with the “Pay for Performance” concept that most companies and Boards have espoused, and certainly is in keeping with the IRC regulations relating to performance-based pay under Section 162(m). The old paternalistic idea of discretionary bonuses based on looking back and deciding, somewhat blindly, how well the company and its executives performed just won’t work in today’s more stringent business environment.
As more organizations switch from discretionary bonuses to formulaic incentive plans, a new series of issues arises. Specifically, what happens when the circumstances change and the performance targets are not attainable? An article in the July 7, 2004 Wall Street Journal entitled “As CEOs Miss Bonus Goals, Goalposts Move” offered examples of where the Board simply lowered the targets and made the same awards regardless of actual performance. That is certainly one alternative, and one that has earned a number of companies and their Compensation Committees the embarrassing reputation for giving into executive greed, at the expense of shareholders. The argument has been that even though the results were not achieved for various reasons, the executives still “worked very hard”, and in order to keep them, the company still needed to recognize and reward their efforts. When shareholders, regulatory agencies, and the media, among other groups, scrutinize executive pay, this logic is fundamentally flawed. Essentially, when the goals of the incentive plan have not been met, then no awards should be payable. The motivational intent to grow the business and achieve performance goals is lost if targets are changed and awards become payable regardless of how well the executive performed.
When the results are not achieved, the company and its shareholders are not rewarded, so why should the executives? This is a major issue that has plagued organizations: by granting the same awards when not warranted by performance, the company actually undermines the integrity of the incentive plans and the spirit of Pay for Performance. No matter how hard an athlete trains for an event, if he only comes in fourth place, he still does not receive a medal; in order to earn that medal in a subsequent event, he must train harder.
Recognizing that every situation is not black or white, there may be justifiable reasons, outside of the executive’s control, for not achieving the desired results. In these instances, and these are generally rare in occasion, it may be appropriate to move the performance target or “goalpost”; but, and it is a big BUT, the potential award must be substantially reduced to reflect the lower expectations and lower level of achievement.
