Incentive Pay, CII update

Strong emphasis on time vesting awards:

CII overhauled its policy on executive compensation, urging public companies to dial back the complexity of pay plans for top executives and set longer periods for measuring performance for incentive pay. The new policy cautions against the pitfalls of performance-vesting awards and encourages companies to explore adopting simpler plans comprised of salary and restricted shares that vest over five years or more. The policy also recommends that companies consider barring the CEO and CFO from selling stock awarded to them until after they depart, to ensure management prioritizes the company’s long-term success. Although performance vesting share plans can work well for some companies, recent studies suggest they may not provide a strong enough connection to long-term company performance on a broad level, and use goals and metrics that can be numerous, overlapping, flexible and hard to understand.

CII notes:

For some companies, emphasis on restricted stock with extended, time-based vesting requirements—for example, those that might begin to vest after five years and fully vest over 10 (including beyond employment termination)—may provide an appropriate balance of risk and reward, while providing particularly strong alignment between shareholders and executives.Extended vesting periods reduce attention to short-term distractions and outcomes. As full-value awards, restricted stock ensures that executives feel positive and negative long-term performance equally, just as shareholders do. Restricted stock is more comprehensible and easier to value than performance-based equity, providing clarity not only to award recipients, but also to compensation committee members and shareholders trying to evaluate appropriateness and rigor of pay plans.

This is in line with work I’ve mentioned previously that Alex Edmans and Tom Gosling have done via the Purposeful Company.

ESG-linked pay, PRI session

I was at an investment conference debating extra-financial linked (Environment Social Governance) pay.

A blog summary is at the PRI:

”….The case for ESG-linked pay

We heard some strong arguments for why ESG factors should be incorporated into pay. Firstly, executive remuneration is a matter of concern for investors when the levels of pay don’t correlate with corporate performance or value generated in the long-term. This is not uncommon, given that incentive plans don’t often work as intended. Secondly, there is evidence to suggest that ESG factors result in positive financial returns and hence portfolio performance. Given that the market doesn’t account for these factors adequately (Alex Edmans work) it would be sub-optimal not to consider them in incentive plans to help deliver long-term sustainable performance….”

In the overall debate, I’ve referenced the Purposeful Company work several times.

This argues (amongst other matters) for a large amount of long dated restricted stock plus incentives around material intangibles (strategy and extra-financial) - this is broadly the position I argued.

Of recent note:

The PwC study looking at EPS / Sharebuy backs and incentive pay.

A Caroline Flammer study suggesting CSR linked pay leads to increase in firm value, long term orientation and social, environmental initiatives and Green innovations.

This study examines the integration of corporate social responsibility (CSR) criteria in executive compensation, a relatively recent practice in corporate governance. We construct a novel database of CSR contracting and document that CSR contracting has become more prevalent over time. We further find that the adoption of CSR contracting leads to i) an increase in long-term orientation; ii) an increase in firm value; iii) an increase in social and environmental initiatives; iv) a reduction in emissions; and v) an increase in green innovations. These findings are consistent with our theoretical arguments predicting that CSR contracting helps direct management’s attention to stakeholders that are less salient but financially material to the firm in the long run, thereby enhancing corporate governance.

SSRN link for Flammer

Purposeful Company: Exec Pay Report

BEIS / PWC report.

PRI blog here.

Causal evidence for benefit of long-term incentives

In ESG world, I wanted to highlight this paper from Caroline Flammer and Pratima Bansal. (H/T Alex Edmans) It’s causal evidence for the benefit  use of long-term incentives. The paper studies shareholder proposals that not only are on executive compensation, but specifically advocate the use of  long-term incentives.  (Link to paper here)

The authors use a “Regression Discontinuity Design”. They compare proposals that narrowly pass (with 51% of the vote) to those that narrowly fail (with 49% of the vote). Whether you narrowly pass or narrowly fail is essentially random, and uncorrelated with other factors. So, it’s causal evidence.

They find that proposals to increase long-term compensation improve long-term operating performance, regardless of whether you measure it using return on assets, net profit margin, or sales growth. 

From abstract " In this paper, we theorize and empirically investigate how a long‐term orientation impacts firm value. To study this relationship, we exploit exogenous changes in executives' long‐term incentives. Specifically, we examine shareholder proposals on long‐term executive compensation that pass or fail by a small margin of votes. The passage of such “close call” proposals is akin to a random assignment of long‐term incentives and hence provides a clean causal estimate. We find that the adoption of such proposals leads to (1) an increase in firm value and operating performance—suggesting that a long‐term orientation is beneficial to companies—and (2) an increase in firms' investments in long‐term strategies such as innovation and stakeholder relationships. 

In sum, Caroline Flammer (LI profile) and Pratima Bansal suggest corporate short‐termism is hampering business success. Authors show clear, causal evidence that imposing long‐term incentives on executives improves business performance. Firms that adopted shareholder resolutions on long‐term compensation experienced a significant increase in their stock price. This stock price increase foreshadowed an increase in operating profits that materialized after two years. Discussed: reasons for these improvements - firms that adopted these resolutions made more investments in R&D and stakeholder engagement, especially pertaining to employees and the natural environment.

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How to live a life, well lived. Thoughts from a dying man. On play and playing games.

If you'd like to feel inspired by commencement addresses and life lessons try:  Neil Gaiman on making wonderful, fabulous, brilliant mistakes; or Nassim Taleb's commencement address; or JK Rowling on the benefits of failure.  Or Charlie Munger on always inverting;  Sheryl Sandberg on grief, resilience and gratitude.

A provoking read on how to raise a feminist child.

Cross fertilise. Read about the autistic mind here.