Human Capital & Careers

Short-Term Incentive Pay Criteria Are Shifting

How much weight should companies give to non-financial metrics like customer or employee satisfaction?
David McCannDecember 8, 2016
Short-Term Incentive Pay Criteria Are Shifting

The criteria for earning short-term incentive (STI) compensation appear to have entered a state of flux, judging by new research from the CFO Alliance.

In particular, some companies are putting non-financial metrics, like customer or employee satisfaction, into the mix. But far more companies should be doing so, according to Ernie Humphrey, a former CFO who is director of content for CFO Alliance.

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Among 188 executives who responded to the alliance’s poll — 82% of whom were either CFOs or controllers — 46% said their company either added new performance metrics to the STI pay calculation or expect to do so in 2017.

That much change in the behaviors companies are looking to motivate with their STI programs “represents a strong indicator that companies realize there is a misalignment between incentives and key drivers of company performance,” the study report said.

In a series of CFO Alliance roundtable discussions this year, participants identified four drivers of company value, and three of them are not reflected in traditional financial metrics, says Humphrey. Those three drivers: customer satisfaction, attracting and retaining top talent, and brand management.

Humphrey also points to 2015 research — a joint project of the American Institute of Certified Public Accountants and the Chartered Institute of Management Accountants — that made virtually the same point.

In that study of 744 senior finance and management professionals in 34 countries, the top value drivers were identified as customer satisfaction, quality of business processes, customer relationships, quality of people, and reputation of brand.

In the CFO Alliance study (see chart at the end of this story), among the participants who said changes have been or will be made to STI criteria this year or next, 9% said some changes relate to customer satisfaction metrics. And 6% said the same for customer retention and employee satisfaction.

Those numbers probably represent an uptick in the proportion of companies prioritizing those areas for STI purposes. The CFO Alliance did not have any historical comparisons, but revenue and income measures have long constituted the vast majority of criteria for STI pay.

Still, Humphrey finds those results disappointing. “I was looking to see more of that, because those areas are becoming a driving force in what companies are tying to accomplish,” he says. “In general, the incentives that are in place today do not inspire behaviors that impact company value.”

Indeed, the study found that 49% of respondents actually recognized that they don’t have the proper incentives in place to optimize customer satisfaction. There was also widespread acknowledgement that there is a lack of incentives aimed at optimizing business processes, attracting and retaining top talent, and enhancing and protecting company brands.

“There’s a big disconnect here,” Humphrey says. “The link between drivers of value and how executives are incentivized is broken. The good news is that CFOs are recognizing these gaps, but they need to do even more.”

When it comes to financial measures, Humphrey was hoping to see more companies incentivizing cash flow. Only 14% of those reporting changes or pending changes to STI criteria said the changes related to cash flow.

Far fewer companies — just 11% of those surveyed — have or soon will make changes to long-term incentive programs, compared with the 46% figure for STIs. But in those cases, the factors driving the changes are similar, according to Humphrey.

Participants in the study, called “2016/2017 Mid-Market Executive Compensation Survey,” actually represented a broad range of company sizes, including many with less than $10 million in revenue and some with more than $1 billion. Almost two-thirds of the sample, though, was in the $250 million to $1 billion category.

CFO Alliance chart