- Nonfinancial metrics adoption. Private companies are increasingly adopting nonfinancial metrics in executive incentive plans, following the trend seen at public companies.
- Varied options for implementation. Nonfinancial metrics can be incorporated through discretionary assessments or more formal incentive plan design. Either way, companies should identify a focused set of impactful metrics directly tied to business and talent strategies.
- The communication aspect is key. Clear communication on nonfinancial metrics is important for both executives and the broader workforce. This includes explaining the rationale for specific metrics and how they relate to the company's strategy and values.
Private companies are increasingly employing nonfinancial metrics in executive incentive plans, consistent with this trend among publicly traded companies.
Private companies have far more governance leeway in their compensation plan design, which can be an advantage in some instances. The adoption has been slower than at public companies, with the most significant gains in annual bonus plans.
These changes are driven by either management or the board, especially by directors who also serve on public company boards. The most significant gains have come in annual bonus plans as private companies are still adopting nonfinancial incentives slower than their public counterparts.
This year has seen an unforeseen complication: the pullback of institutional investors around use of the term ESG (environmental, social and governance) and ESG’s increasing politicization. This development has boards of both public and private companies questioning the right direction. In this environment, it’s important to pause and determine whether the metrics are still appropriate for the company’s strategy. If they have been carefully selected based on core values (for example, DEI) or long-term business goals (such as making measurable progress toward converting a fleet of vehicles from gas to electric to cut long-term costs), then companies have been on the right track, with no need to change direction.
Typically, at private companies, such executive compensation design processes are initiated through senior executive and board-level conversations around the importance of their specific nonfinancial metrics and by determining how to develop a scorecard of performance measurement in these areas.
The board and senior management review current company initiatives and identify those that are most critical for continuous monitoring and improvement. Industry considerations often factor heavily into this process because some nonfinancial metrics are more critical to companies in certain industries than others.
As more private companies push ahead with nonfinancial metrics, they are assessing where improvement is desired, and incorporating those metrics into the company's annual incentive plan design. While private company incentive plans are less formulaic or less structured than those in publicly traded companies, they also incorporate much greater use of discretion in determining the size of awards to be paid.
For private companies with a heavily discretionary approach to annual incentives, nonfinancial performance considerations can be incorporated into the discretionary assessments of performance to determine the appropriate incentive awards.
Compared to the complexity of a public company incentive plan, this can be a fairly simple process. However, as boards of private companies increasingly implement more structured annual incentive plans with several financial and operational performance measures — each with its own weighting — consideration must be given to how to appropriately incorporate these nonfinancial metrics into the portfolio of operational performance measures.
One important lesson from public companies is the need to balance the interest in focusing on ESG- or nonfinancial-based metrics in incentive plans that are easy to communicate and administer. If a private company board moves to tie incentives to nonfinancial goals, a clear communication strategy on plan design and award opportunities for the executive team is warranted, particularly if those metrics add complexity to formulaic plans.
That means such plans cannot have an overwhelming number of performance metrics in the plan design. To ensure that there is sufficient focus on each of the metric areas, each performance measure should be at least 10% of the total award opportunity.
Given the broad scope of factors that can be reasonably considered nonfinancial, there is ample opportunity for private organizations to identify and prioritize a reasonable number of impactful measures that directly relate to their business and talent management strategies.
Finally, while private companies are somewhat insulated from the growing list of compensation disclosures required for public companies, the need for clear communication about the organization's focus on these important nonfinancial metrics is absolutely warranted for both the executive and the broad-based workforce audiences.
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