A recent study has found that companies that set more challenging goals for executive compensation had higher total shareholder return the following year compared with companies that set easier goals.

Annual incentive goals set by some compensation committees for executive compensation have been criticized for being too easy to maximize payouts.

According to the research by Pay Governance, TSR was higher the year after, whether or not the challenging goals were met.

The study looked at 83 public companies that provided earnings per share or net income for 2012, and used one or both in setting annual executive incentive goals. A goal was considered challenging if it was set at or above the midpoint of guidance or the analyst expectations.

The compensation consulting firm found that 59% of companies set their incentive goals at or above the midpoint of analyst guidance, and 53% of those companies met or exceeded these goals.

Brian Lane, a consultant at Pay Governance, says setting goals at or above analyst expectations represents a major challenge. “Among the myriad factors to consider in setting goals, compensation committees should understand how goals compare to internal strategic plans, external guidance and external expectations of performance,” he adds.

Ira Key, managing partner at Pay Governance, says goals should stretch executives and the company, but should not be so hard as to be potentially unattainable and demotivating.

Another study, conducted by consultancy Towers Watson, found that enduringly high-performing companies differentiate their compensation programs and align them to their strategies and where they are in their life cycle.

Enduringly high-performing companies were defined as members of the S&P 1500 with the most sustained outperformance in TSR compared with the S&P 1500 overall in the 15 years up to 2013. Towers Watson identified 50 such companies, but did not divulge their identities.

In a video interview this month, Doug Friske, executive compensation global leader at consultancy Towers Watson, said these companies tended to have a much longer-term orientation to their practices.

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High-performing companies were more likely to have longer vesting schedules. “For example, on stock options, 70% of these companies had vesting schedules that would last beyond three years, whereas in the broader market it is roughly 40%,” he said.

In these companies, roughly two thirds use cliff vesting, compared with 40% of other companies.

They are much more prone to use stock options. “In fact, of these companies, 27% … only use stock options; that is their only long-term incentive program,” said Friske.

Almost half (40%) of the incentive plan is delivered in stock options. For the broader market, more than half the value is in performance plans.

According to Friske, companies should take away the following:

  • Life cycle matters — where a company is in its life cycle should have important considerations for companies and how they design their compensation. Proxy advisory firms try to fit a single lens onto programs, but they should evolve as companies go through the growth, midlife and mature phase. “How they structure their programs really does matter in relation to their strategies,” he said.
  • Taking a longer-term orientation definitely has some value, and being willing to differentiate from what is out there.
  • Compensation programs have to be viewed from the standpoint of a company’s ability to differentiate itself strategically to attract talent in the marketplace. “Companies need to take the offensive in terms of how they view these programs and not take the defensive on why they do what they do, and how they structure their programs, so they can endure long-term sustainable performance,” says Friske.

One outperforming company is The Walt Disney Company. According to the 2015 proxy statement, its strong TSR “dramatically” outperformed the S&P 500 for the one-, three-, five- and 10-year periods ending in 2014.

The compensation committee has structured CEO Bob Iger’s compensation so that 90% of target compensation is contingent on financial results and stock performance.

According to the proxy, 70% of Iger’s performance-based annual cash bonus opportunity is dependent on performance against four financial measures: segment operating income, diluted earnings per share, after-tax cash flow and return on invested capital. The remaining 30% is dependent on individual contributions to predefined qualitative goals tied to the company’s strategic priorities.

Iger also receives an annual equity award that comprises 50% options and 50% performance-based units. “The realized option value depends on the performance of Disney stock and the realized performance-unit value depends on three-year achievement of relative TSR and EPS performance,” the proxy states.