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Earning It

A recent study finds that many corporate executives can expect modest salary increases and tougher performance goals in 2012. Experts say this development is the continuation of an ongoing trend, and signifies a greater role for HR in the design and communication of incentive plans.

Friday, December 16, 2011
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For many Americans, the perceived gap between the handful of individuals sitting at the top of the organizational chart and the much larger group of employees below them has never been wider. The public outcry about executive compensation has steadily increased during the last three-plus years -- especially as rank-and-file workers continue to struggle through the economic freefall that began in 2008.

A new study, however, finds that more companies are modifying incentive-based compensation programs to better align executive pay with company performance.

A survey of 190 organizations, ranging from Fortune 50 companies to emerging high-growth firms, found that more than two in five (42 percent) companies plan to raise their annual performance targets for 2012 incentive programs. 

The poll, conducted by independent compensation consultancy Pearl Meyer & Partners, also found 52 percent of respondents indicating a 2 percent to 4 percent salary increase for executives next year, and another 10 percent saying they anticipate a salary freeze or decrease in 2012.

This marks a break from the annual 4 percent pay growth that has continued through most of the past two decades, according to the New York-based Pearl Meyer.

The move toward moderate salary increases and tougher performance goals for execs really began nearly two years ago -- with good reason, says Jim Heim, managing director at Pearl Meyer.

"Progressively tougher goals for 2010 and 2011 made sense," he says, "given that the bulk of companies were showing year-over-year improvement on financial and operational measures."

But improved results are not necessarily the case heading into 2012 -- and an additional factor seems to be at play as well, Heim says.

"Heightened scrutiny of executive-pay programs has made many companies hesitant to set a performance target that is below the prior year's performance," he says. "The rational approach in any given year is to set a performance target that's realistic given the company's specific challenges and opportunities for that year."

Hopefully, he adds, "what we're not seeing is the implementation of irrationally tough target performance hurdles or additional opportunities for discretionary bonus awards that are not linked to financial or operational progress."

A new survey from New York-based Towers Watson does not seem to find that companies are setting forth "irrationally tough target performance." In fact, nearly three in five (58 percent) of 265 mid-size and large corporations expect to fund their annual incentive plans at or above target levels, based on their companies' year-to-date performance -- even though 61 percent of them expect their total shareholder return for 2011 to decline or remain flat.

The Towers Watson study also found that 61 percent of the companies expect their annual bonus pools for 2011 to be as large or larger than those for 2010.

The ongoing push from boards and investors to raise performance standards while simultaneously shifting more pay to an incentive-based "at risk" model requires HR executives to strike a delicate balance between performance and retention, says Heim.

"HR leaders need to be prepared to provide data-driven evidence if this shift begins to negatively impact the organization's ability to attract and recruit talent," he says.

Many HR professionals work closely with their boards and financial leaders to strike that balance, says Irv Becker, national practice leader of executive compensation at Philadelphia-based The Hay Group.

"HR leaders will need to partner with the finance area to ensure that the board has significant information around the company's performance as well as the peer group and industry performance," says Becker. "Boards will have an expectation that management will provide the analytics to help them make the right decisions on setting both annual and long-term performance goals."

Marc Stockwell, a principal and national practice leader with Findley Davies' compensation and rewards management consulting practice in Toledo, Ohio, says executive-compensation trends may have shifted the primary role of HR leaders a bit away from plan design and more toward communication.

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"As the boards have assumed more responsibility for these plans -- and in many cases retained their own independent consultants -- the HR leader's role has become secondary and supportive in the design role, but more critical in the communications role," he says.

Looking at long-term incentive program design, Stockwell says, the increasing reliance on performance-based awards is clear within large companies -- and continues to be reflected in the practices of large and small public companies.

"While traditional stock options are still prevalent, they are often paired with performance-based awards that allow executives to earn stock based on financial performance; most often measured in terms of growth, profitability and/or total shareholder return," he says. "I think this is occurring because most boards do not believe that management is solely responsible for increasing the share price."

Heim adds that "institutional shareholders have advocated this shift across multiple industry sectors and company sizes," noting that "the largest companies are the ones under the most pressure to implement such programs, given the level of scrutiny their pay programs receive from investors."

This evolution is likely to continue -- and is likely to continue to create additional challenges for HR in the future, Heim says.

A combination of equity-dilution concerns and line-of-sight considerations has "tended to reduce the size of the population eligible for long-term incentives over the past five or so years," he says, with long-term incentives being more and more limited to those employees with the most impact on share-price performance.

"At the same time, there is pressure to provide additional performance hurdles to long-term incentives, and to lengthen the vesting period or bolster ownership requirements to ensure true long-term alignment with shareholders," he says.

As such, "HR needs to be positioned to support pay decisions that will provide the most bang for the buck by identifying critical-need populations," Heim says. "HR also needs to be deeply involved in developing principles-based processes for allocating these long-term incentive pools.

"In the 'say on pay' era," he says, "it is increasingly important that pay decisions be defensible to both investors and employees reading the proxy filing."

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