The use of nonfinancial metrics in annual incentive plans is increasing year-over-year, according to new research. Experts say the move to incorporate nonfinancial metrics in incentive plans will likely accelerate in the face of the COVID-19 pandemic as some compensation committees look for ways to rely less on financial measures to compensate executives.
“This crisis has already caused companies to rethink how to measure short-term performance,” says Mike Esser, managing director at Pearl Meyer’s Los Angeles office. “For 2019 there was a dramatic increase in nonfinancial metrics, measuring things like strategy, safety, customer satisfaction, employee engagement—the ESG measures. The impact of COVID-19 on the various stakeholder groups results in a social issue that executives are responsible for, and I suspect a lot of metrics [in annual incentive plans] will be nonfinancial moving forward.”
Although traditional financial metrics such as earnings per share, revenue, EBITDA, and operating income are “holding steady” as the most common measures of performance for annual incentive plans, Esser says softer metrics are creeping in more frequently and taking up a bigger piece of the pay-for-performance pie. According to Pearl Meyer research, roughly 61% of the top 200 companies are using nonfinancial metrics in annual incentive plans.
Looking ahead, Esser says as a result of the COVID-19 pandemic, companies may include measurements such as operational execution, supply chain issues, customer service, and workforce retention and optimization in annual incentive plan metrics.
Generally, annual incentive plans take up an increasingly smaller portion of the executive compensation mix each year, Esser says. And early 2020 proxies show that payouts were down for 2019, coming in at around 100% of target for most companies.
Ultimately, compensation committees meeting right now are asking questions on alternative performance metrics, midyear plan adjustments, end-of-year discretion, widening performance ranges, lowering targets, and other changes to annual incentive plans, compensation consultants say.
“More and more companies are considering changes as they see the annual plan essentially thrown out the window,” Esser says.
According to Pearl Meyer, roughly 314 Russell 3000 companies disclosed material executive pay changes due to COVID-19 as of May 1, largely focused on base salary and cash retainer cuts.
“Employees and the world at large are going to have intense scrutiny on how [companies] reacted to this crisis and if it was fair,” Esser says. “There is going to be heightened social awareness of compensation from now on.”