Pay for Performance OR Justification for Compensation? That is the Question...

I have recently done several presentation covering the possible impact on U.S.companies once Management Say in Pay (MSOP) becomes mandatory. Around the world MSOP is usually defined as a shareholder vote on compensation or remuneration practices.  The pending Dodd-Frank bill includes MSOP. The current document calls for a vote on compensation every two or three years. In most countries with MSOP this vote is non-binding, but it gives voice to a powerful statement on how shareholders view remuneration.  Most of my source materials come from academic studies that reviewed the influences of compensation votes in locations such as the United Kingdom, where it was rolled out years ago.  In general, these studies conclude that MSOP has had little impact on pay levels or pay frequency.  (Links to some of these studies can be found at the end of this posting.)  In fact, the only consistently measurable impact appears to be a movement from compensation based on service period (time-based pay) to compensation based on achieving performance metrics.

Performance-based pay is almost universally touted as a positive result of the MSOP revolution.  The odd thing is that the movement from time-based pay to performance-based pay has not really impacted compensation levels.  How can this be?  This would seem to indicate that, in the past, compensation professionals and their companies have perfectly matched time-based compensation to corporate performance.  If this wasn't true, wouldn't pay levels have become much more variable as a result of adding the riskier and more leveraged components of performance metrics?  If we had perfect alignment all along, it is unlikely there would be such an outcry for more transparency and shareholder input.

Just as companies in the U.S. are starting to look at how to roll out plans that will pass MSOP muster, many of our consultant are looking at historical data from other countries to determine how to design programs that will receive the vote of shareholders in the future.  What is often missed is that in Europe these programs are often being derisively referred to as "justification for compensation" programs.  I don't believe it will take long for institutional shareholders in the U.S. to jump on this bandwagon.

The real questions is whether shareholders in the U.S. will give companies that same multi-year leniency as they did in the U.K and other locations that have mandatory MSOP.  Will we be allowed to have only a loose linkage between goals, payouts and corporate performance, or will shareholders immediately hold us accountable for accurate alignment? My vote is on the latter.

It is time to start discussing this with your shareholders and management.  Preparing fully aligned performance metrics can take several months at large companies (and it may be near impossible for some small companies.) Over the next twelve months you need to ask yourself if you will be driving toward true "Pay for Performance" or simply trying to provide "Justification for Compensation".  The choice may be yours today, but it is unlikely to be yours in the future.

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