The incentive illusion

When designing performance share plans, remuneration committees often face a fundamental philosophical divide: Do we reward management for the operational metrics they directly control, or for the final value delivered to shareholders?

Pure financial metrics offer a clean link to internal execution, explaining why over half of Europe’s top Large Cap companies include profitability as a metric in their LTI plans. It is highly controllable and rewards actual, tangible execution. But relying solely on pure financial metrics introduces two distinct catches.

First, the market disconnect. Executing flawlessly on internal operations does not guarantee the market will care. An executive team can deliver record earnings and hit every EPS milestone, but if macroeconomic sentiment shifts, multiples compress, or the broader sector falls out of favor, the share price will still decline. In this scenario, a misalignment occurs: management secures a maximum payout based on internal accounting, while shareholders suffer real-world losses.

Second, the short-term trap. Depending on how the measurement period is structured, financial targets can inadvertently incentivize value destruction. If an EPS target is rigidly tied to a one- or two-year horizon, a management team could theoretically hit their numbers by slashing R&D budgets, pausing strategic investments, or delaying critical infrastructure upgrades. They secure their payout today, but systematically cannibalize the company’s future market position and long-term viability.

On the flip side, market-based targets like TSR serve as the ultimate test of market credibility. They ensure total alignment with shareholder outcomes. Yet, as the March 2026 shock illustrates, relying solely on absolute market metrics leaves executives completely exposed to sector-wide volatility outside their control. Companies risk rewarding a CEO simply because a geopolitical conflict raised commodity prices, or penalizing them because of a global supply chain crisis.

The strategic challenge isn’t about finding a magic formula (even though a growing percentage of Nordic plans now blend multiple metrics to hedge these risks). It is about deeply understanding the DNA of each metric and ensuring the chosen criteria reflect your company’s actual strategic intent.

Choosing the metric is only the first step. The architectural design of how a metric is measured is what ultimately shapes executive behavior.

Consider the measurement horizon. Evaluating financial metrics like EPS through discrete, annual targets versus a single, three-year cumulative goal serves entirely different strategic purposes. If a Nordic retailer requires heavy first-year capital expenditure to transform its supply chain, annual targets might result in a zero-payout during the investment phase. A three-year cumulative target, however, can absorb this short-term dip, incentivizing management to weather initial costs for later margin expansion. The optimal structure simply depends on what the business needs to achieve in its current lifecycle.

When applying market metrics, the benchmark and the underlying math present similar trade-offs. Relative TSR is typically measured by comparing a company’s performance against a peer group or a market index. However, the Nordic region significantly lags behind broader Europe in adopting relative TSR within LTI plans.

Using a broad market index is transparent but introduces composition risk; an engineering firm could mathematically underperform simply because an unrelated sector inflated the index. A bespoke peer group helps isolate true operational execution from broader macroeconomic events. However, identifying and constructing a robust, comparable peer group is arguably the most difficult, and most valuable, component of relative TSR design.

Once a suitable peer group is established, boards must determine the measurement mechanics: do you rank performance or demand excess return? Ranking is straightforward but can trigger a payout even when absolute returns are negative, simply because the company lost less value than its peers.

While stakeholders may view these as opposing strategies, precise calibration ensures they drive toward the same performance standard. Mathematically, achieving a top-tier rank requires the same level of outperformance as hitting an excess return target. The choice is not about differing mechanics, but rather which framework communicates the boards’ strategic intent most clearly.

Finally, depending on the overarching strategy, boards may decide that a primary metric operating in a vacuum is insufficient. In these cases, committees can introduce structural guardrails. An underpin acts as a binary gateway, for example requiring a minimum Return on Capital Employed (ROCE) to ensure an EPS target isn’t achieved through inefficient capital allocation. Alternatively, a modifier can act as a dial, adjusting the final payout up or down based on secondary priorities, such as specific sustainability milestones.

There is no universally perfect design. However, without rigorous backtesting, the mechanics of a plan can easily produce unintended outcomes.