Value in 60 Seconds: Exec pay linked to ROIC: Sustainability of ROIC is as important as its level

2 Jul 2023 · 1 min

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Executives can artificially inflate single-year ROIC by cutting investments while keeping profits high. To prevent this, compensation should be banked and paid out over years, so executives return awards if ROIC spikes then falls. Sustainability matters as much as the number itself.

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Is a longer-term ROIC, 3 or 5-year average, more important than the single year?
Yes. I think it's important to understand, especially for executives, because you can goose your ROIC up by just saying, oh, we're going to cut off on all investment and not spend anything on maintaining the business while the numerator or NOPAT is still rising. And so you do want to look at that over time. The way we would address that from an executive compensation perspective is that in any given year, the award won would not all be paid out at one time. It would be banked over time so that if you were able to just goose it and have a really good year and then hit the tank the next, you'd have to give some of that back. Yes, I love looking at longer-term return on invested capital because, as I mentioned before, sustainability of return on invested capital is just as important as the level of return on capital.