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Todd Sirras and Greg Arnold Featured in Directors & Boards recently published an article, “Compensation Committees and the Incentive-Plan-Information Gap,” by Semler Brossy’s Todd Sirras and Greg Arnold.

In this article, Sirras and Arnold outline four strategies to help close the information gap in getting incentive plan goals approved.

  1.  Pressure test the company’s planning and budgeting process. Many companies set annual incentive targets equal to the budget for the year. This simple approach makes sense and aligns incentive payouts with other indicators of financial performance regularly communicated throughout the year.
  2. Inform goal-setting process with supplemental data and analysis. Committee members can get more comfortable when the goals are put in context, particularly the ranges used for threshold or maximum. Backward-looking analysis like probability of achievement, in which financial results are analyzed for a group of comparator companies, can provide a baseline of what may or may not be achievable based on historical results.
  3. Ask pointed questions about external influences. The deeper the committee’s understanding of the range of business outcomes, the better a committee can determine the right goals for incentive plans. Human nature often causes people to overly discount the likelihood of extreme outcomes, both positive and negative. This discounting can lead to incentive goals and ranges that are too tight and cause the incentive plan to be more of a lottery than a mechanism to align management performance with compensation.
  4. Institute good governance process. Many of the committees we work with find it helpful to use a two-step process to approve goals. The first step is a review meeting in which the initial proposal is presented and committee members can review the data, ask questions, and contemplate the proposal.

Read the entire article, “Compensation Committees and the Incentive-Plan-Information Gap.”