Non-financial metrics may become a bigger part of the incentive calculation.
Retailers like Target are using compensation metrics for senior executives related to redesigned store experiences and channel optimization in response to the evolving retail landscape. Meanwhile, oil and gas companies like Chevron are using metrics related to employee safety and environmental consciousness to promote business stewardship.
These types of strategic metrics vary across industries and companies, but their overall purpose is the same: to incentivize investments in the business that may not lead to short-term gains (and, in fact, may lead to short-term losses) but will affect the company’s ability to operate, innovate and grow over the long term.
Such approaches are gaining traction as stakeholders across the spectrum accept the importance of a broad range of strategic priorities.
Investors and proxy advisory firms have long favored the use of quantitative objectives in incentive plans, and consequently, financial measures have taken the lion’s share of incentive metric weightings. But investors may be open to embracing non-
financial strategic metrics.
In his 2018 letter to CEOs, BlackRock chairman and CEO Larry Fink wrote “no company … can achieve its full potential” without a clear long-term strategy and understanding of its environmental and social impact. Such understanding, he argued, is essential to prepare for potential challenges and sustain performance in an ever-changing world.
Other investors seem to agree. In Ernst & Young’s 2017 survey of decision-makers at buy-side institutions globally, 92% of respondents agreed that “over the long term, environmental, social and governance (ESG) issues — ranging from climate change to diversity to board effectiveness — have real and quantifiable impacts” on businesses and their financial performance. Evidently, there is shareholder demand for focus on such strategic priorities, and companies can use them to give their short-term incentives an element of long-term orientation.
Nevertheless, companies must demonstrate the importance of their chosen strategic metrics as well as the rigor of their goals and goal-setting processes. With strategic metrics, the link to shareholder value creation is not as self-explanatory as with earnings or total shareholder return, for example, and such goals risk being dismissed as “soft goals” if companies do not treat them with the same transparency and processes that they do financial goals.
The following are ways that companies can successfully incorporate strategic metrics:
• Explain the link between chosen strategic priorities and value creation. Abercrombie & Fitch considers their select strategic priorities “leading indicators of future financial performance.” Drawing this connection clarifies why these metrics should matter to investors and that they strengthen pay-for-performance alignment.
• Carefully balance financial and strategic metrics. Verizon’s short-term incentive metric weighting is 95% financial and 5% strategic; American Express’ is 55% financial and 45% strategic. While there is clearly no “correct” percentage that should be strategic, companies should thoughtfully balance strategic metrics with financial ones and explain the rationale behind their chosen mix.
• Where possible, choose quantifiable metrics. American Water Works measures environmental leadership as a multiple that compares performance to the EPA national drinking water industry average and discloses threshold, target and maximum performance levels. Quantifiable metrics lend clarity to the goals and how they are measured.
• Define achievements associated with each performance level. Libbey outlines the accomplishments associated with threshold, target and maximum talent development performance. Such disclosure makes it easier to understand the concrete meaning of a given non-quantifiable performance level.
• Consider relative metrics. Anthem uses consumer centricity both on an absolute basis and relative to industry peers as measured by difference in Net Promoter Scores. Relative metrics imply a level of objectiveness in the goal-setting process since achievement is defined by performance relative to relevant companies.
• Consider different metrics for different executives based on their roles and the results within their line of sight. Mattel and LabCorp are two companies with different strategic goals for each named executive officer. Their approach and corresponding disclosure suggest that the strategic goals are carefully conceived and will incentivize people to focus on the strategic priorities that they have most control over.
• Set the goals up front. By defining and disclosing the strategic priorities and various performance levels at the start of the performance period, companies can demonstrate that they are treating strategic goals with the same robust goal-setting processes and rigor that they treat their financial goals.
Katherine Barrall is a senior associate and Kathryn Neel is a managing director at Semler Brossy Consulting Group