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NFPCC Original Article: Timing Long-Term Incentives


We are now in the 8th year of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Among other things, the implementation of Dodd-Frank meant the majority of public issuers had to learn to navigate the waters of shareholder advisory votes on executive compensation, better known as “Say on Pay”. Every year, management teams, boards of directors, outside advisors such as attorneys and compensation consultants, shareholders and proxy advisory firms are put through the paces to determine if a public issuer’s compensatory arrangements warrant shareholder support.

While much discussion has been had about the various elements of compensation (development of peer groups, best practices in incentive plan metrics, appropriate quantum of pay, etc.), one element that often doesn’t receive enough attention is the timing of long-term incentive awards. Barring unique circumstances, we posit the argument that the ideal time to grant long-term incentives in the public company arena is in the fourth quarter of the fiscal year.

Current Prevalent Practice

According to a number of studies analyzing long-term incentive data, a strong majority of public issuers (roughly 90% of Russell 3000 issuers) continue to grant long-term incentive awards to executives in the first quarter of the fiscal year. This is likely due to the fact that companies historically granted long-term incentives early in the year to ensure retention and motivation of top talent in coordination with the payout of cash bonuses for the prior year. Despite the dawn of Dodd-Frank, the task of bridging a “gap in compensation” from the previous year’s grant to the next grant that would occur over one year later was too much of an obstacle for companies to try and overcome.

We see a couple of problems with this common practice. First, the status quo in public company compensation is to provide a substantial portion of an executive’s compensation opportunity in variable, at-risk compensation in the form of cash bonuses and/or long-term incentives. When the majority of a CEO’s reported compensation for the fiscal year is delivered early in the year, a substantial element of the compensation disclosure that is addressed following the completion of the fiscal year is effectively set. Second, oftentimes more than one year will pass between the Q1 grant date and the occurrence of the shareholder Say on Pay vote for the fiscal year in question. This can really complicate a Compensation Committee’s ability to react to events that occur throughout the remaining three quarters of the fiscal year that may weigh heavily on the minds of shareholders and proxy advisory firms ahead of Say on Pay voting.

Considerations for Q4 Grant Date

In the current Say on Pay environment, parties responsible for navigating Say on Pay votes have to keep up with a variety of key decision-making factors such as fast-evolving market conditions, proxy advisory goalposts that are constantly in motion, share usage, etc. The last thing management teams and Compensation Committees should be doing is prematurely setting one of the most important compensation levers early in the fiscal year. Shifting the long-term incentive grant to later in the year positions the board and management to make more appropriate long-term incentive award decisions that have an intended relationship to the financial performance data points (TSR, return metrics, etc.) proxy advisory firms will use to make Say on Pay vote recommendations.

As noted previously, there are pitfalls to be mindful of when exploring such a shift in timing.  They may include:
  1. Perceived abdication of power to proxy advisory firms, something that would make many independent directors and c-suite executives cringe.
  2. Perception of executives losing out on normal course compensation for a period of time.
  3. Perception of excessive executive pay in the year that transition takes place.
  4. A lack of performance management and compensation correlation.

While there are various strategies that companies can consider to help mitigate such concerns, temporary pains should be anticipated when exploring such a transition. In the end, the cost-benefit relationship leans heavily in support of Q4 grant practices. If you have questions related to this, please reach out to your NFPCC advisory team to explore further.

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