The National Association of Corporate Directors today released a proposed framework for pay-for-performance principles and definitions to help guide companies as they prepare for the 2014 proxy season.

The NACD said the need for a consistent approach to supplemental compensation definitions stems from the Dodd-Frank Act, which requires companies to disclose the relationship between compensation paid to its senior executives and the financial performance of the company. “In today's business climate, companies are increasingly providing additional executive compensation disclosures to shareholders, but without standard definitions in place,” said NACD CEO Ken Daly.

In the absence of standard definitions, many companies are taking widely different approaches to how they assess and communicate the link between executive pay and company performance. As a result, investors and other stakeholders are having a difficult time effectively comparing companies.

In order to establish a common language that companies and boards can use, the NACD has developed the following four principles to assessing and communicating the link pay for performance:

Standard definitions. In order to enhance pay and performance disclosures, companies should adopt standard “baseline” definitions of pay and performance, and a similarly standard methodology of presenting pay-for-performance analysis, the NACD said.

Companies should further have the choice to go beyond the baseline and present additional information in order to more effectively communicate with stakeholders. While the baseline definition of “performance” should include total shareholder return (TSR), for example, “an isolated emphasis on TSR can result in excessive focus on quarterly financial numbers and encourage short-term thinking,” the NACD said. “In the interest of avoiding over-reliance on any single metric, companies may choose to include other financial and non-financial performance measures that they believe to be relevant”.

Consistent time horizons, oriented to the long term. The time horizon for measuring both pay and performance should be consistent with one another. Specifically, NACD recommends that companies consider a three- or five-year baseline—as opposed to a one-year baseline—to highlight the connection between the compensation plan and the creation of long-term value for the company and its shareholders.

Disclosure beyond the CEO. NACD believes companies should disclose pay-for-performance data for the CEO as an individual, in addition to disclosing a second pay-for-performance calculation that includes all other named executive officers as a group. For most companies, this group includes the chief financial officer, and the three most highly compensated executive officers other than the CEO and CFO.

Importance of board judgment and company context. NACD believes directors are responsible for exercising informed business judgment in carrying out their fiduciary objective of promoting long-term value creation for the corporation. This responsibility applies to all areas of corporate governance, including duties related to executive compensation.

For more detailed information about the NACD executive compensation definitions and principles, download a copy of NACD Perspectives: Pay for Performance and Supplemental Pay Definitions here.