Maintaining Motivation in 2025 Short-Term Incentive Programs

The ongoing macroeconomic uncertainty caused by tariffs, executive orders, and reductions in government contracts has upended short-term incentive programs. [1]

In our previous article on tariffs, we discussed how boards can create a proactive framework from which to judge the potential impact of tariffs on compensation plans and evaluate whether in-flight changes or discretionary adjustments might be warranted.

As uncertainty surrounding executive actions and legal rulings persists, the likelihood that short-term incentive programs may not pay out for many executives this year increases. In some cases, a lack of payout may be warranted. Boards, however, still desire a degree of flexibility in their compensation programs to incentivize good business management, especially for relative outperformance in difficult times. Year-end discretionary adjustments may, in limited cases, offer a solution.

Discretion can be something of a third rail in compensation discussions, and discretionary adjustments may be perceived to excuse management missteps or poor performance. Such instances have made shareholders, perhaps justifiably, wary. When used, communicated, and sized judiciously, however, discretionary adjustments can help rally the troops during periods of difficulty, align the organization towards the metrics that matter, and re-establish the link between pay and performance in a way that is fair to both executives and shareholders. In such cases, we’ve found that a well-designed discretionary scorecard may be a useful tool in the board’s arsenal.

Determining if Discretionary Adjustments to Short-Term Incentives are Warranted

First and foremost, any adjustments should aim to maintain pay-for-performance alignment. Unlike the COVID-19 pandemic, which saw some sectors rise while others fell, tariffs and government spending reductions are negatively impacting many more organizations and were not entirely unpredictable. A robust, long-term strategy should be able to handle periodic shocks, and executives should not be let off the hook if they were not ready for them. One of the goals of a good compensation program is to reward nimbleness, agility, smart mitigation practices, and relative outperformance.

The crucial question for boards, then, is “When is it appropriate to consider discretionary adjustments?” While all organizations will have unique considerations, we’ve found that, broadly, there are two situations where discretionary adjustments can reward nimble executives without breaking pay-for-performance philosophies:

1. When management makes a qualitative, but objectively measured, improvement to the company’s long-term outlook. This may include launching a new product earlier than planned, reconfiguring a product’s design, sourcing, or distribution to be more cost-effective, achieving a key customer win, or improving product quality or service offerings.
2. When the company outperforms its peers. Improvements in relative market share, brand reputation, margin growth, etc., are still useful benchmarks, as everyone is “going through this together.” Outperforming the field still indicates outsized performance.

Hallmarks of well-received discretionary adjustments
They prioritize long-term growth. Discretionary adjustments should still support the long-term strategic goals of the organization, rather than paper over short-term problems. Pay should reward good positioning for the future.
They’re reciprocal: If you make an upward adjustment to payments in response to external factors you need to be willing to make a similar downward adjustment if things end up better than expected.
They’re appropriately sized. While leaders who maintain organizational sustainability, even without immediate financial results, can be rewarded, the goal should be to get executives closer to threshold, not over target.

If boards feel confident that one (or both) of the above situations applies, the next step is to lay the groundwork for possible adjustments. As we previously discussed, first steps include:

1. Ensuring plan language allows the Committee an appropriate degree of discretion on adjustments
2. Aligning on scenarios where discretion may be necessary
3. Sizing the impact of potential changes to incentive plans

The Discretionary Scorecard: Highlighting the Metrics that Matter

The next step for boards is to develop a framework to evaluate what success in the current business climate looks like. One strategy we’ve seen work during past macroeconomic shocks is a discretionary scorecard, which is a non-binding, unweighted set of strategic metrics that the board deems indicative of success during turbulent times.

Communicating these metrics in advance to executives allows boards to approach the topic of discretionary adjustments with flexibility and confidence. At the end of the year, boards can refer back to this scorecard to determine if discretionary adjustments to incentives are warranted.

Such scorecards offer companies three key advantages:

1. They offer hope. An incentive program that won’t pay out, through no fault of the employees, can be demoralizing.
2. They give people direction. A well-designed scorecard says, “We know we can’t control the tariffs, but here is a list of variables we can control.”
3. They provide rationale in advance. Shareholders are justifiably skeptical of claims that the board “can evaluate performance at the end.” Establishing the parameters of success in advance will bolster the company’s case with shareholders if/when adjustments are disclosed in the proxy.

The sooner this scorecard is developed, the more effective it will be. Since yearly goals have already been set, a discretionary scorecard will run in parallel with the current incentive plan, and crucially, it comes with no weightings among measures or a promise of payment. Because it is non-binding, the scorecard gives the board time and flexibility to determine any adjustments later in the year. If the board feels like relief is warranted based on discretionary factors, they already have a strong, quantifiable foundation from which to base their decision.

The trick, then, is choosing what metrics and elements support long-term strategic priorities while still mitigating the risks from tariffs. In our work navigating the challenges posed by tariffs and related executive actions, we have come across several “buckets” of metrics that boards can mix and match according to their unique challenges and goals:

Adapt 🡪 Respond to disruption and reposition the business

• Speed and impact of tariff mitigation
• Pricing strategy shifts
• New sourcing, manufacturing, or distribution pathways
• Maintaining supply chain continuity
• Cost containment without damaging future growth or quality
• Workforce agility (redeployments, upskilling)
• Liquidity
• Retention of key talent and customers
• Brand and reputation protection

Grow 🡪 Position for long-term value creation

• New product/service launches
• Share gains in key markets
• Key customer wins
• Growth in recurring/high-margin revenue
• Digital acceleration
• Expansion into new channels, geographies, or customer segments
• Strategic initiative advancement (e.g., tech investment, operational improvements)

Outperform 🡪 Achieve Relative Success Against Peers

• Relative Market Share
• Margin Preservation
• Relative Growth
• Relative Gross Margin

Evaluating the Size and Scope of Potential Adjustments

Well-received discretionary adjustments need to be well-targeted. Sizing adjustments appropriately and selecting the right candidates are essential. Consider the shareholder’s experience, too, when sizing. If shareholders have struggled, then discretion—especially if used generously—will be less compelling.

1. Who should participate in any discretionary adjustments? Boards will need to decide whether all executives participate or whether the most senior executives, with the greatest need for alignment with shareholders, warrant consideration. Most often, boards will treat executives as a team, but sometimes individual contributors with an outsized impact could be recognized. Candidates for discretion should have a meaningful effect on the facets of the business directly affected by or that are vital to overcoming present challenges.
2. What are the most important criteria by which to apply discretion? As seen in the case studies below, it is best to selectively choose a few key metrics instead of the entire gamut, focusing on areas where executive decisions can make a tangible impact on long-term growth trajectories.
3. What level of discretion is appropriate? Discretionary changes, in almost all cases, should aim to bring payouts to threshold, or somewhere between threshold and target. In most cases, relative outperformance would have to be exceptionally high to warrant moving payouts above target.

Scorecards in Action: Three Case Studies

Boards will likely need to pull metrics from several of the buckets listed above to design their scorecard, which may resemble the hypothetical scorecards below. As a note, none of these criteria should be weighted, and discussion of the scorecard (and progress against it) will need to become a standing agenda item for the Compensation Committee for the remainder of the year. Finally, a scorecard is not a replacement for the incentive plan. It’s a reference point all parties can refer to when evaluating how well management is keeping the business moving forward, and it will serve as a basis for whether discretion might be warranted later on.

Case Study #1	Consumer Products Company
Context	– Proposed tariffs will significantly increase costs – Consumers are deemed to have limited ability to absorb price hikes, and consumers may trade down, or not buy at all, if costs increase – Peer group has a mixed exposure to tariff-related costs
Adapt	– Ensure supply chain continuity with existing vendors; renegotiate where possible – Diversify supply chain as required while maintaining product quality or delivery reliability – Contain costs and shore up margins without damaging future growth or brand equity
Grow	– Grow digital sales to decrease middleman costs – Develop lower-cost products or “budget tier” offerings and value bundles
Outperform	– Relative market share – Relative margins – Relative growth rate

Case Study #2	Manufacturer
Context	– Company faces a significant increase in tariff-related costs – Company has already made significant investments in domestic production relative to peer group – Adjustments to supply chains will take significant time
Adapt	– Maintain brand loyalty and customer satisfaction through direct messaging on ongoing efforts to mitigate cost increases and dampen price impact for consumers – Manage costs without damaging future growth or brand equity – Re-prioritize ongoing strategic initiatives based on feasibility and net present value
Grow	– Highlight benefits of domestic production vs. competitors – Leverage existing domestic investments to increase market share – Improve / streamline current quality commitments and systems – Grow service offerings
Outperform	– Relative market share – Relative quality – Relative EBIT margin

Scorecard #3	Health Care Company
Context	– The company faces a significant loss in research funding due to canceled government grants – Proposed tariffs will increase input costs – A federal contract for medical supplies was not renewed – There is further uncertainty around the status of other on-going grants and contracts with key customers
Adapt	– Optimize current revenue and liquidity – Rethink current research and product timelines and redeploy key talent accordingly – Expand government contracts and connections to stay abreast of upcoming changes
Grow	– Identify new distribution pathways for current products – Improve / streamline current quality commitments and systems
Outperform	– Monitor relative margins – Expand market share with current products and treatments – Demonstrate relative strength in continued innovation leadership

Conclusion

There is no telling how prolonged or how extreme the present uncertainty around tariffs, executive actions, and federal spending cuts will be, making it all the more important for boards to create stability in the areas they can control. Market instability is likely to negatively impact incentive payouts, and end-of-year discussions around incentives may become contentious as a result. In some cases, these outcomes will be warranted. But executives who have continued to move the business forward in meaningful ways may deserve some leeway. It is far smoother for everyone – Compensation Committees, shareholders, and management – if the groundwork for any changes is clearly laid out in advance. Boards can help themselves tomorrow by agreeing on which factors will support such adjustments today.

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1As a note, we’ve decided to focus on short-term incentive plans, as those goals were set (for most calendar fiscal year-end companies) before tariffs went into effect. In many cases, executives have not had enough time to react meaningfully and influence payouts. Long-term plans, on the other hand, likely offer enough time for companies to adjust and tend to feature more relative metrics, like rTSR, which naturally assess relative performance. Adjusting long-term plans also comes with added accounting challenges beyond the scope of this article..(go back)