Short-Term Gain, Long-Term Pain

Aligning executive interests with shareholder interests.

The Issue

Shareholders complain about executive pay systems that reward for short-term gains while they are left holding the proverbial bag well after performance has waned.  With the heavy mix of long-term incentives in executive pay programs, our executive pay system is seemingly long- term in nature, but can still miss the long- term alignment mark.  Why is this the case?  What is the appropriate time horizon over which to measure shareholder value?  How can the issue of pay and performance alignment over time be addressed?

Farient’s Point of View

Investors themselves bear some responsibility for the relentless focus on short-term gains, but despite some short-term profit-taking by investors, a central theme for executives is to manage for the long-term prosperity and sustainable value of the business.  There are a number of issues with executive pay programs that allow for short-term profit-taking without the underpinnings of sustainable performance, including short-term incentive plans that can reward handsomely for results that don’t lead to value creation and relatively short vesting periods and performance cycles in long-term incentive plans.  But one of the most significant factors driving misalignment is most often the length of option windows (i.e., the time between vesting and expiration), and the corresponding ability of the executive to accumulate options and then cash out during a secular market runup.

How Farient Can Help

We rountinely assess timing issues for our clients.  To do this, we assess the time horizon of the business, as indicated by investment time horizons relative to the time horizon of the pay programs.  In this regard, we assess vesting schedules, performance measurement periods (including entry and exit points), option windows, clawbacks, holdbacks, ownership guidelines, and even executive behavior (e.g., do executives accumulate options and cash them out in a runup, or do they hold their options generally to term) to determine the ability and likelihood of executives to realize high gains in the short-term when performance is not sustainable in the long-term.  We then recommend changes in program design and features to help companies to better align pay and performance outcomes over time. 

Copyright 2011 - Farient Advisors, LLC

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