DESIGNING COMPENSATION PROGRAMS

Executive compensation professionals are intensely interested in the ongoing debate around the question of whether management of US public companies is, for various reasons, too focused on short term performance horizons, to the detriment of long term competitiveness. Our interest derives, of course, from the question of whether the design of compensation programs contributes to the alleged problem.

It seems, at a minimum, fair to say that if the critics have a point, the design of compensation programs may be a contributing factor. Most stock-based equity compensation programs can tend to focus management attention on short-term stock price fluctuations. Performance share plans and long-term cash performance plans typically foster a somewhat longer-term perspective, but even these almost always consider performance periods of only three or four years, not enough time to measure success in managing most businesses for long-term competitiveness.

This note suggests a simple tweak to the design of executive stock options – separating the vesting from the exercisability of options – that could be used by compensation committees to nudge managements towards a longer-term focus. Two premises of this note are that this tweak can be implemented in a win-win fashion for executives and companies who are willing to stake some money on long-term competitive success, and that it is likely to be viewed by more stakeholders as a more attractive approach than alternatives currently being widely considered.

Jan-Mar 2015 Issue

Cleary Gottlieb Steen & Hamilton LLP