Beyond STIs and LTIs: Executive reward has outgrown traditional incentives

Across many organisations, short-term incentive outcomes are often clustered around target levels, creating a perception that annual incentives have become a relatively predictable component of remuneration. This creates an uncomfortable challenge for Remuneration Committees. If executives consistently receive similar incentive outcomes regardless of economic conditions or business performance, is the short-term incentive still serving as a reward for exceptional performance? Or has it effectively become a variable form of fixed remuneration?

In recent years, Boards have also appeared more willing to apply discretion to short-term incentive outcomes. A formulaic scorecard may produce an answer, but the Board must still determine whether it is the right answer when considered against overall organisational performance, stakeholder outcomes and the context in which results were achieved.

This may indicate that formal scorecards do not always capture genuine performance, or that the operating assumptions underpinning targets have changed materially. Discretion can be an important governance safeguard; however, if Boards repeatedly spend significant time setting targets that quickly lose relevance and then recalibrating outcomes, it is reasonable to ask whether the underlying design remains efficient and effective.

The fundamental purpose of an incentive is simple: to influence behaviour and clarify where executives should focus. Incentives also link performance to pay, align the interests of executives and shareholders, and support retention. Most importantly, they signal where the Board expects management to exercise judgement, direct effort and create sustainable value for shareholders and other stakeholders.

Incentive design also plays an important role in shaping organisational culture. Reward influences not only what executives prioritise, but how they pursue outcomes: the measures, targets, underpins and judgement embedded in a framework can reinforce expectations relating to conduct, risk, collaboration and stakeholder impact. Poorly chosen measures may unintentionally encourage behaviours that undermine the desired culture, while a well-designed framework can support both the strategic destination and the manner in which it is achieved.

However, some executives question whether traditional LTIs genuinely achieve this objective, because the effectiveness of a performance-based incentive depends on the organisation’s ability to establish meaningful targets. If a target is perceived as unachievable, it may cease to motivate or focus effort. If it is set too low, the plan may reward expected, or below-expected, performance and attract criticism from shareholders and proxy advisers.

In today’s rapidly changing economic and geopolitical environment, this task has become more complex. A three-year performance period may span conditions that bear little resemblance to those prevailing when targets were set. Interest rates, commodity cycles, geopolitical events and market sentiment can materially influence outcomes; forecasts are revised, strategic priorities evolve and industries can be disrupted within months rather than years.

As a result, some executives may view LTIs as outcomes over which they have limited influence rather than as effective performance incentives. Where participants cannot see a credible connection between their decisions and the eventual result, motivational value weakens. Adjustments, discretion or retrospective explanation may be justified, but repeated intervention raises questions about whether traditional structures can continue to support credible long-term performance assessment.

Perhaps the most compelling argument for change is that alternative approaches are available, simpler, and may be more effective in driving executive focus, and may actually take less Management and Board time to implement. Just under a decade ago, Norway’s sovereign wealth fund issued a position paper calling for CEO pay to be paid in a combination of cash and restricted equity ‘locked-up’ for a minimum of 5, and up to 10 years, on the basis that “the accuracy of finally calibrated performance targets is illusory” and “simplicity ensures that Board and CEO can focus on business”. This position was more recently restated as part of the fund’s response to ISS’ Annual Global Benchmark Policy Survey.

Looking beyond the Australian market, the use of restricted stock is common in the US and has also had an uptick in prevalence in the UK-market in recent years. However, in Australia, such practices are still sparse as the Australian governance expectation from proxy advisors and shareholders typically demands performance targets to be attached to equity grants.

Glencore provides an interesting FTSE 100 example (with a secondary ASX listing imminent). In 2024, Glencore announced its intention to replace the CEO’s traditional short-term incentive and long-term incentive arrangements with a single variable remuneration model known as Career Shares. The value of each annual grant is informed by a multi-year performance look-back; once granted, the shares vest over three years, subject to performance underpins, and cannot be sold during employment or until two years after the CEO leaves. The model retains an upfront assessment of performance but places greater emphasis on sustained ownership and long-term shareholder alignment than on repeatedly setting and testing conventional forward-looking incentive targets. The trade-off is that it places greater weight on Board judgement and retrospective assessment, requiring clear governance, robust disclosure and confidence that discretion will be applied consistently.

Alternative models broadly fall into three categories. Ownership-led approaches use restricted equity held for extended periods (though such approaches are rare in the ASX environment); combined incentive plans collapse the traditional short-term incentive and long-term incentive into a single annual assessment delivered over the longer term, as seen at Wesfarmers and JB Hi-Fi; and simplified performance-conditioned equity seeks more consistent outcomes at a lower quantum, supported by achievable underpins, as illustrated by BlueScope’s Alignment Rights plan.

These approaches recognise that executives may place greater value on understandable rewards than on highly contingent plans assessed many years into the future. Long-term equity ownership can align executives with shareholder wealth while permitting management to adapt as operating conditions change, rather than pursue success through a narrow set of predetermined measures. Executives participate in value creation only if their decisions generate sustainable outcomes and they remain invested long enough to experience the consequences of those decisions.

This does not necessarily mean abandoning pay for performance. Rather, it may mean challenging whether the traditional separation between annual and long-term incentives remains the most effective way to deliver it.

The debate is not whether executives should be rewarded for performance; few would dispute that principle. The more difficult question is whether today’s frameworks genuinely influence management behaviour, support strategy and produce outcomes that Boards can defend. Rather than preserving familiar structures by default, Boards should test whether the current model provides clear line of sight, reinforces the desired culture, remains credible across changing conditions and justifies the governance effort required to operate it. If it does not, redesign should be a live option.