Question

Executive Compensation Performance Measures and Standards One you have defined the compensation item to be used here as part of question #1 define the performance measures that you would use to measure its application both in the short term and long term.

Answer 1

Performance measures in short- and long-term incentive plans (i.e., STIPs and LTIPs) should differ. When considering Say on Pay, investors and ISS both consider whether the STIP and LTIP measures are different, and typically give firms higher marks for making distinctions. This is because risk gurus advocate balance in the measurement system through a diversification of measures as well as time horizons.

Risk is mitigated if there is a combination of: (1) top line measures (to signal growth), (2) bottom line measures (to signal profitability), (3) return on capital measures (to signal the efficient use of capital), and (4) strategic measures (to signal how well the company is positioned for the future). Further balance is achieved through the diversification of time horizons, with short-term measures differing from long-term measures. The idea is that such balance will reduce the likelihood that executives will bet the farm and perhaps demonstrate exceptional results in the short-term, only to crash and burn in the longer term.

In general, there are important benefits to diversifying measures and time horizons, better matching the time horizon of decisions with results, and ultimately, rewards. But using different measures in the short- and long-term plans isn’t necessarily bad. There may be situations in which the same measures should legitimately be used in both the short- and long-term plans, not to mention the fact that using the same measures is simpler.