Meaning
Internal subgroups of a board of directors that are responsible for setting the pay and incentives for top executives govern the alignment between performance and reward. The compensation committee evaluates the performance of the leadership team and determines their salary and bonus structures. This group ensures that the incentives provided to managers do not lead to excessive risk taking.
Incentive Design
Creating a balance between short term goals and long term value requires a deep understanding of the market. When the compensation committee designs a package, they must consider the retention of key talent and the expectations of shareholders. This work consumes the energy of the directors as they navigate complex tax and legal requirements.
The mechanism involves the selection of specific metrics that will trigger a payout, such as revenue growth or profitability targets. Each metric is chosen to encourage behaviors that benefit the company over several years.
Pay Oversight
Transparency in how executive pay is calculated helps to maintain trust within the organization. Because the compensation committee must justify their decisions to the full board, they often rely on external consultants to provide market data. The cost of this oversight is measured in the fees paid to advisors and the time spent on reviews.
Metric Selection
Periodic updates to the performance targets are necessary to keep the leadership team focused on the right objectives. Once the compensation committee sets the goals for the year, the executives can direct their capacity toward achieving them. This alignment is critical for the execution of the company strategy.
