Should Executive Pay Be More 'Long-Term'?

Much criticism is directed at executive pay on the ground it lacks sufficient emphasis on the “long-term.” The meaning we give to “long-term” in this context is not always clear. Three years appears to be the earn-out period most frequently covered by incentive awards that are described as “long-term.” Descriptions are contained in proxy statements and surveys of incentive pay practices.¹ In particular cases, as discussed below, “long-term” can be significantly longer than three years.

The earn-out requirements that apply to a long-term award vary considerably. An earn-out may simply require that the executive continue in employment over the term of the award (with exceptions for certain circumstances, such as death or disability). On the other hand, an earn-out may require that performance targets be met. Examples are targeted growth in earnings per share or in return on equity. Total shareholder return (change in stock price plus dividends during the earn-out period) is another frequently used target. (Adjustments typically are made for falling short of the target and sometimes additional amounts are earned for exceeding the target.)