Performance-based pay programs are increasingly popular for executive compensation packages. By nature, they are intrinsically linked to earnings per share, or EPS. However, they have significant drawbacks that impact shareholders and even the long-term growth of the company. Jeremy L. Goldstein is a New York City lawyer and partner at Jeremy L. Goldstein & Associates, which specializes in serving executives and high-level management teams in the areas of executive compensation and corporate governance. His extensive experience serving clients in these areas and his profound understanding of related laws enables him to deeply analyze the pros and cons of performance-based pay programs. Furthermore, he provides his clients with legal advice regarding such executive compensation plans.
From a business perspective, a general debate continues to rage between the benefits of promoting short-term performance financially versus focusing on sustainable growth over a longer period of time. This directly feeds into the benefits of performance-based compensation plans for executives and high-level managers. A closer look reveals how performance-based pay programs may favor a strong focus on short-term performance.
Corporate performance is often measured by stock share prices, and earnings per share is a primary driver of this. Earnings per share is driven by the number of outstanding shares as well as the share price. Management understandably has greater control over earnings than stock price. Management also has control over the number of outstanding shares. Therefore, it is clear that performance-based incentive or pay programs that are linked to earnings per share may be manipulated by management to efficiently manage the company’s capital. In addition to manipulating share price advantageously, they may also reduce the share count to exercise control over earnings per share.
However, is this assumption supported by factual evidence? James F. Reda conducted a study analyzing the performance of companies that utilize total shareholder returns versus EPS growth metrics. The result of this study revealed that companies that measure their performance with earnings per share growth metrics generally outperform their counterparts. While this is a broad study that fails to analyze the numerous factors at play within a specific corporation and the actual outcomes, Reda’s study supports the concerns raised by numerous shareholders recently.
Opponents to the use of earnings per share growth metrics are notable and numerous, and they are increasingly ringing alarm bells. These opponents include individuals like Hillary Clinton and Laurence Fink, who is the CEO of BlackRock Inc. Union groups and other significant shareholders have also criticized this practice. CtW Investment Group and others support their concern by stating that such performance metrics put an excessive amount of control in the hands of executives. Their concerns extend to the lack of accountability of executives. This accountability relates to the sustainability and amount of cash flows that are raised for reinvestments and for various capital improvements. They cite the Federal Reserve’s current low-interest-rate policy as a driving incentive for this practice. Large share buybacks as well as how earnings are managed can result in managerial manipulation of the earnings per share and of overall performance metrics.
Increasing Pressure on Corporations
Looking forward, such opponents see an even greater cause for concern. For example, what may happen if smaller shareholders, such as CtW Investment Group, garner support for major institutional players, such as Vanguard or BlackRock Inc.? This may place increasing pressure on corporations to improve how they structure their executive compensation plans. It may also place greater scrutiny on the manipulation of EPS and the impact that this has on the business.
Recently, Larry Fink penned a letter to CEOs of large-cap corporations, and this letter highlighted the significant potential impact that short-termism may have on corporations and their shareholders. In this letter, he stated his concern over the growing pressure for companies to meet short-term or quarterly goals at the expense of long-term growth and value accumulation. Furthermore, he stated that external pressure is resulting in corporate executives and leaders increasingly manipulating EPS to provide a return to shareholders immediately. This may be through an increase to the dividend or through share buybacks. He believes this is at the detrimental cost of underinvestment in skilled labor, innovation and other essential drivers of long-term growth. To underline his warning about short-termism, he mentioned that it is increasingly difficult to justify support at the managerial level when management has failed to develop a strategic, long-term plan for the company and to utilize credible performance metrics. Because short-termism and managerial control over earnings per share are linked to performance-based pay programs, Fink’s letter justifies opponents’ concerns.
The excessively high compensation packages of executives have received extensive attention and criticism from shareholders for years. While shareholders have and will continue to evoke the eradication of such practices for obvious financial reasons, today’s shareholders have more to be concerned about than the superficial impact of such compensation. Today’s shareholders demand increased attention on realistic and justified performance metrics and solid, long-term goal setting. This drives their growing concern over performance-based compensation plans.
Jeremy Goldstein’s Perspective
Jeremy L. Goldstein has been serving corporate clients, including compensation committees, for many years. He clearly understands the arguments of both sides of the debate as well as the ramifications. The ideal compromise is to establish executive compensation plans that tie compensation to the achievement of defined goals. These may be operational and financial goals that are clearly outlined and that are aligned with the company’s strategic and well-developed plan for long-term growth. However, the specific details of an executive compensation plan should be customized specifically based on the situation. Because each situation has unique elements that must be considered, corporations and their compensation committees should consider seeking legal advice from a law firm specializing in this niche legal area.
Despite the current popularity of performance-based pay incentives linked to earnings per share, it is reasonable to anticipate that the corporate environment may see a dramatic shift in the near future. Today’s companies should create compensation plans for executives with the expectation that performance metrics and company goals in relation to these plans may receive greater scrutiny. In addition to standing under the weight of such scrutiny, a well-drafted and thoughtful compensation plan that is established around the company’s goals and objectives is in the best interest of the company’s future and of the shareholders.
About Jeremy Goldstein
Jeremy L. Goldstein has devoted his legal career to the areas of corporate governance and executive compensation. Goldstein’s law firm was specifically established to provide corporate clients with extensive expertise in this critical area. His vast experience has included serving numerous large corporations on related legal matters. Some of his previous cases have involved Goldman Sachs, Duke Energy, Oracle, The Dow Chemical Company and numerous others. Goldstein is considered to be one of the top attorneys in the United States who specializes in executive compensation.
Goldstein earned his B.A. from Cornell University and his M.A. from the University of Chicago. He later earned his doctorate from New York University. In addition to advising and representing his clients, he serves the American Bar Association Business Section by sitting as a chair for its Mergers and Acquisitions sub-committee. He further contributes to his field by speaking and writing frequently on topics related to his legal specialization. Outside of his office, Goldstein supports the local community by serving on the Board of Directors for the Fountain House. This is a charitable organization that supports adults living with and recovery from mental illnesses.