Executive compensation has long been used to measure performance and retain talent. However, when boards evaluate compensation solely through the lens of compensation and retention, they invite scrutiny from investors, proxy advisors, and regulators, particularly regarding strategic alignment and long-term value creation.
With increased focus on pay for performance, executive compensation program and CD&A disclosures send a message far beyond the boardroom, demonstrating the quality of governance, strategic clarity, and credibility. Effective committees not only approve pay programs, they also challenge them. They listen to opposing views, apply disciplined oversight, judgment, and consistency, and continually test alignment with strategy. To guide this process, here are five questions boards should ask their compensation committees.
1. What do we actually get?
Executive incentive plans shape behavior, not just reward performance. Incentive design influences how leaders prioritize decisions, allocate capital, and manage tradeoffs. When incentives are misaligned with strategy, they can encourage behavior that undermines long-term goals, even if short-term results seem acceptable.
Beyond stated planning goals, boards should consider the motivation created by incentive metrics and goals. What actions are executives most required to take? What risks can they accept or avoid based on how performance is measured and rewarded?
The continued disconnect between incentive outcomes and strategic intent raises questions about board oversight.
2. Are the incentives aligned with the direction of the business?
Static compensation programs in a dynamic business environment can exhibit a disconnect from business reality. As change accelerates, executive compensation may lag behind strategy, but continued reliance on traditional metrics can inadvertently lock leadership into past models rather than future growth.
Compensation committees should regularly test whether incentive designs are evolving as business models, industry trends, strategic objectives, risk profiles, and capital allocation change. Aligning with yesterday's strategy may feel safe, but it sends the wrong signal that the board is ready for what's next.
3. Will informed shareholders understand and support our payout results?
Even technically sound compensation decisions can undermine credibility if they are difficult to explain, seem defensive, overcompensate for performance, or provide large one-time rewards. Compensation outcomes are judged externally without full context and must withstand investor scrutiny regarding performance alignment. Boards should pressure test pay decisions through an investor lens. Can the rationale be defended against financial performance and can be simply and rationally explained as disciplined supervision?
Overly complex explanations or reliance on exceptions, such as special recognition without a compelling story, undermine credibility, even if the intentions are good.
4. How does our exercise of discretion strengthen or weaken trust?
Discretion is a powerful governance tool, but it goes both ways. If used carefully and judiciously, the board will be seen to exercise judgment in exceptional circumstances. Repeated use creates an expectation of entitlement and signals that the incentive is less stringent.
Investors and proxy voting advisors pay close attention to discretionary rights. The committee should clearly explain why it applies and how it corresponds to actual performance. Good use of discretion builds trust and strengthens governance decisions. Used poorly, it invites skepticism.
5. Do our compensation decisions create a clear and reliable pattern of pay for performance over time?
Governance credibility is built on consistency and transparency. Incentive programs must evolve with strategy, but investors evaluate compensation over time for principled judgment, rigor of performance, and alignment with shareholder experience.
Remuneration committees need to ensure that design changes strengthen rather than destroy the governance narrative. Evolution must be intentional and reinforce a consistent and reliable narrative around dividend levels, business performance and shareholder alignment.
Future-proofing the role of the remuneration committee.
Future-ready boards recognize that executive compensation serves two important purposes:
- As a leadership tool for rewarding, retaining, and properly motivating executives.
- As a governance signal to stakeholders who evaluate the effectiveness of the board of directors
Strong oversight begins with disciplined questioning and thoughtful consideration of diverse perspectives in the boardroom. Committee members bring a variety of experiences and risk lenses. Bringing those differences to the surface will enhance decision-making.
The chair of the remuneration committee plays a vital role in ensuring that all views are considered and weighed to enable durable and defensible pay decisions. Committees that consistently apply this thinking are better placed to support sustainable value creation and withstand scrutiny.
