Defining executive compensation in times of uncertainty can be a challenging task. External market forces make managers work harder, but payouts rarely reflect their increased effort. With Obermatt’s indexed performance measurement, incentive payouts become more robust and incentive plans more motivating - in any economic cycle.
Managers want compensation that is reliable and reflective of their performance in the market, while shareholders value transparency of performance. Many companies unknowingly face high risks from extreme compensation payouts. While they focus on absolute bonus targets, a constantly shifting market environment often undermines these efforts.
The risk of landing in an extreme situation, namely paying no bonus or paying an excessive bonus is unnecessarily high. These situations are shown as the red bars in the graphs below. The probability of no payout (zero compensation, the first red bar in the graph) in the case shown was almost 22%, which is a clear risk for retention and motivation. At the same time, the risk for maximum payout was almost 20%, which can lead to a reputational risk and create expectations that are difficult to meet (last red bar in the graph). The desirable green bars, where more performance leads to more pay, are unfortunately rather small (graph on the left), with only a roughly 30% chance of a favorable payout. The analysis was made for a large industrial company (LTIP-Articles on LinkedIn). For non-cyclical companies, such as those in the consumer goods sector, the result is almost the same. For smaller companies, the results can be even riskier.
Compare these results against the payout probabilities with the Obermatt Rank Method. The likelihood of compensation payouts falls within a more reliable range, approximately 75% (compared with less than 30% without Obermatt).
When Obermatt improves performance measurement by indexing key figures against a customized peer universe or implements a Triple Bottom Line view, the risk of unwanted payouts drops while the likelihood of desired payouts rises. Thus, companies meet the reliability and transparency demanded by shareholders, while enjoying broader acceptance of compensation, also internally.
"If a company performs better than others, then its people deserve to earn more."
Publicly traded companies face significant challenges when it comes to executive compensation, particularly during uncertain and turbulent economic times. Compensation systems should align the interests of executives with those of shareholders, but market volatility and external pressures can complicate this process. Selecting realistic and effective performance goals, managing shareholder expectations, and retaining top talent become increasingly challenging. But there is a transparent and reliable solution: Indexing Performance.
Balancing Pay with Performance and Shareholder Scrutiny: It's difficult to set realistic compensation targets for executives in an uncertain market. When performance declines due to external factors beyond management's control—such as inflation, political uncertainty, or supply chain disruptions—the company's compensation committee faces a dilemma. If executive pay is reduced to reflect the poor performance, it could demotivate key leaders. However, if the company pays large bonuses or other incentives while laying off employees or losing money, it faces intense scrutiny from shareholders, proxy advisory firms, and the public. The transparency and legitimacy of compensation plans are becoming increasingly important.
Executive Retention: During uncertain markets, a company’s compensation package can suffer from unexpectedly low or high payout levels, meaning that the likelihood of falling within a reasonable payout range is disappearing. This can mean the risk of losing key talent or having to justify high payouts to proxy advisors and the public.
Staying competitive means attracting and retaining top talent, while also understanding a company’s true position in the market. However, setting targets and measuring performance can be challenging, especially in uncertain times. Executive compensation should be reliable and reward for long-term value creation, not only short-term profit maximization.
Attract and Retain Top Talent: A crisis-proof LTIP (Long-Term Incentive Plan) is a crucial tool for attracting and retaining the best talent in the market. It provides reliable, performance-based payouts even during uncertain times, which is vital to family-owned businesses that may lack the financial data and market benchmarks to accurately assess their position against competitors.
Drive Performance and Growth: This indexed Obermatt LTIP creates both performance clarity and crucial growth incentives within the company. Establishing the LTIP-Index helps overcome the challenge of a missing public stock price and is key to building and maintaining market leadership.
Obermatt has been involved in the introduction of financial performance measures into compensation for over 20 years and serves approximately 44% of Swiss companies with relative performance measures. While too many companies still limit their long-term compensation plans to stock returns, Obermatt has experience with all forms of quantitative performance indicators, which have been published in award-winning books and dozens of articles, enabling its clients to design compensation more reliably. As a customer, you receive the Triple Bottom Line analysis that serves as the basis for ESG compensation. Obermatt guides the selection of the financial and ESG performance indicators, the target setting for each metric, the calibration of the compensation function and prepares the documentation of the Compensation Rules. This applies both to annual compensation, STI (short-term incentive) and multi-year plans, LTI (long-term incentive).
To help you increase the relevance of strategic non-financial performance indicators (ESG) in your company, we offer to analyze your situation free of charge. You will receive a written report on your compensation system with strengths/weaknesses analysis. CEO Dr. Hermann Stern presents the results of his analysis to you and other decision-makers in your company in an in-depth, personal dialogue and answers your questions.