Although pay for performance is a nearly universal objective of executive compensation programs, there is little agreement on how to measure it and monitor it. Companies often seem to believe that it is obvious that pay varies with performance, while many investors feel that there is little evidence of a strong correlation between the two. This report explores five interpretations of the “pay for performance” concept, presents a practical way to measure it, assesses the concept’s prevalence, and explains how directors can monitor and improve pay for performance at their company.

Five Interpretations of “Pay for Performance”

An analysis of “pay for performance,” as used by the business community, reveals that there are at least five interpretations of the concept.

1. Pay versus target pay is tied to performance Many companies believe that they achieve pay for performance because they award compensation that is above a target level when performance is good and below a target level when performance is poor. For example, in its 2010 proxy statement, Procter & Gamble describes pay for performance this way: “We pay above target when goals are exceeded and below target when goals are not met.” [1] However, few institutional investors and proxy voting advisors are comfortable with a pay for performance concept tied to target pay levels, as they believe that, under this construct, some companies may adopt needlessly high target pay levels and reward poorly performing executives with pay levels that, albeit lower than those for well-performing executives, remain above the market.

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