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Calibrating Pay to Performance

The final requirement in aligning pay with performance is putting the pieces together and making sure that “how much” is reasonable given the measures and performance targets.
Neither boards nor shareholders like surprises. From a governance standpoint, boards have an obligation to understand how the incentive plan will operate at both anticipated and unanticipated performance levels. This is particularly the case if plan payouts are not capped.

Scenario Testing provides a basis for committees to understand the implications of actual payouts relative to performance. Payout levels against results should always be evaluated under a variety of potential performance scenarios. This testing often leads to discussions about the payout curve. A straight-line payout between threshold, target, and maximum is common but may not be appropriate in all cases. The question is: does performance that is halfway between threshold and target goals warrant half the payout? The answer is at the heart of the ***calibration discussion***. In some cases, the answer is “yes,” and the straight line is appropriate. In others, it is a decided “no,” and the payout curve between threshold and target may look like a hockey stick with minimal payouts until performance nears target.