No quick fix for long-term bonus plans

September 24, 2013

By Robert Cole

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Fidelity Worldwide wants long-term bonus plans to be just that – “long term” as much as “bonus.” For the asset manager, that means forbidding executives from cashing in their awards for five years – even if share grants have vested earlier. It’s hard to argue with this. But the policy would have side effects and need careful implementation.

To pension funds, and other investors whose funding liabilities stretch across decades, even five years might seem quite short. Corporate pay packages must strike a balance. Make them too long and the incentive component is diminished. Moreover, rival companies are all too willing to buy execs out of long-term bonus plans. Make plans too short, and executives will be tempted to run strategies that pump up near-term profitability at the expense of sustainable value creation.

Fidelity wisely underscores the distinction between the vesting and holding periods. Equity-based bonuses can be fixed relative to corporate and individual performance over, say, three years. But so long as executives are made to hold the shares received for a further two years, shareholders know that corporate strategies must pass the tests posed across longer periods of time. Hence Fidelity says it will vote against long-term pay plans unless they have a five-year holding period.

Back-loading long-term awards makes intuitive sense, although in reality the motivational power of deferral is hard to gauge. The longer the time horizon, the greater the doubt that the decisions of individual executives can be attributed to actual outcomes. Still, a five-year holding period would certainly restrain executives from reckless short-termism.

The snag is that in many cases, adopting Fidelity’s approach would amount to a real-terms reduction in value for the executive: the longer managers have to wait, the more they will discount the value of rewards that may, or may not, turn up. And that means the best executives may demand more money upfront, or bigger promises about deferred pay. That may be a price worth paying for packages that are better balanced. But whether it stacks up will vary between industries and companies. Fidelity is on to something, but it shouldn’t be too prescriptive.

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