The Pros and Cons of Linking Executive Compensation to Leadership Goals

compensation for executives

Executive salary structure varies across not only positions within the C-suite, but across industries and companies. One thing that remains consistent (almost ubiquitous) among the highest-level leaders, however, are compensation incentives that tie into leadership goals. This type of performance-based compensation has long been the standard. But is it the best way to attract and retain top talent?

Performance-based compensation puts the onus on leaders to live up to expectations set by the company. On the surface, it’s a quid-pro-quo agreement that seems to make sense for both parties. Yet, below the surface, there are often ambiguities that muddle the path to achieving these goals and earning the compensation that accompanies them.

Today, structuring compensation-based goals demands clarity and transparency. Here’s a look at what that means for employers and executive leaders seeking to prove themselves.

The argument for goal-based executive compensation

There’s a reason leadership-based bonuses have remained stalwart in executive compensation structures. Leaders are tasked with elevating the company to new levels of success, and incentive-laden packages reward this success incrementally. From stock-based incentives that vest over a predetermined period to cash bonuses paid quarterly or annually, leaders reap the rewards of their efforts when they’re realized by the company.

There’s a certain fairness and transparency to these incentives. The goal is predefined—for example, “post positive EBITDA growth of more than 10% this year.” The reward is also predefined—for example, “$50,000 in company stock options, increasing by $5,000 for every 2% over the goal.” With every other variable of the agreement defined upfront—time, parameters, extenuating circumstances, measurements, etc.—any agreement between an executive and the company is, for all intents and purposes, made in good faith.

In many instances, tying compensation incentives to defined leadership goals creates a pact between executives and companies that aligns everyone in the same direction, toward shared goals. It’s a tried-and-true way to set expectations, rewards and focus.

Key takeaways

  • Goal-based incentive programs are a tried-and-true compensation standard.
  • Transparency of expectations and rewards are key driving factors in their success.
  • Clarity is crucial when it comes to standards, measurements and timeframes.
  • Agreements on compensation represent a shared pact between executive and employers.

Potential pitfalls underlying compensation incentives

The role of the executive is changing—as are expectations of what executives are responsible for, how they’re expected to achieve results, and the nature of those results. As metrics for success become qualitative rather than quantitative, it’s getting more difficult to predefine the expectations and rewards surrounding executive compensation plans.

What constitutes a successful ESG leadership initiative? How will the company’s DEI efforts translate to improved shareholder value? How do companies track early markers of success in a five-year pivot into new markets? As executives sign on to helm these projects and many like them, they want assurances that their efforts will net them access to compensation. Meanwhile, companies want to know that executive efforts are manifesting in long-term value. Before they can agree on an incentive structure, there are questions that require answers.

When faced with long-term, qualitative leadership goals, it’s important to recognize the potential for hedging. Without well-defined, numerical outcomes and predetermined benchmarks, companies and executives can move the goalposts to justify a compensation agreement. In doing so, it becomes less and less a good-faith alignment on mission, and more and more a power struggle—and a situation to avoid.

Key takeaways

  • Qualitative goals are difficult to quantify, and present challenges in defining upfront.
  • Long-term goals make it more difficult to assess executive performance in the short-term
  • Both sides need to make concessions when it comes to establishing expectations upfront.
  • Obfuscation or ambiguity in goal-setting will create a power struggle down the line.

Transparency is paramount when establishing incentives

Bridging the gap between compensation incentives and leadership expectations starts with transparency. Organizations need to outline clear and definitive incentive thresholds, with as little ambiguity as possible. On the flip side, there need to be contingent clauses built into these agreements to ensure that executives have a fighting chance to achieve them.

Often, simple adjustments to classic incentive agreements are enough to reestablish a foundation of trust. For example, realigning executive performance with internal goals as opposed to market-driven benchmarks. Moreover, more companies are beginning to stratify goals to reward incremental changes that may take years to manifest, such as new DEI or ESG initiatives.

Ultimately, it needs to be within the power of executives to achieve the compensation incentives they agree to. Seeing those goals fade with market shifts or dissolve due to extenuating factors will discourage progress and create a rift between leadership and the company. Transparent, attainable, quantifiable goals are paramount.

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