A subtle shift toward sales at Macy’s …

When it comes to executive comp, it’s worth keeping in mind a fundamental assumption behind the whole process: Incentives are intended to drive behavior. That means that when you see the board changing the chief executive’s incentive structure, however subtly, pay attention: It may just tell you something about their hopes and fears.

Consider Macy’s (M), which filed an 8-K on Thursday with an amendment to the compensation agreement of the company’s 58-year-old chairman and CEO, Terry J. Lundgren.

At first glance, the amendment doesn’t seem to change a lot: Lundgren’s base salary remains at $1.5 million a year, where it was when this particular agreement was originally signed in 2007. The contract continues to run through Feb. 28, 2011, which is the same date as in the 2007 agreement.

And then there’s the amended Schedule 1, which looks like pretty much the same hairy table that closed the original agreement. Indeed, quick arithmetic suggests that, if Lundgren hits his targets — for earnings before interest and taxes, for sales and for cash-flow — he is still eligible for a bonus of 150% of his salary, or $2.25 million. Moreover, a little additional calculation shows that hitting the uppermost thresholds in each of those categories will continue to earn him 390% of his salary, or $5.85 million. (One minor change at the upper end: The old formula kept increasing from there, while the new one doesn’t; there’s also an absolute ceiling of $7 million.)

So what changed? Simple — the emphasis the board is putting on each of those three key elements. Sales are up, in that they now are more important in determining Lundgren’s bonus than before. Meantime, EBIT and cash-flow are de-emphasized. So if he hits all his targets dead-on, sales account for 33% of his bonus, up from just 20%. EBIT makes up just over half, down from 60%. And cash-flow makes up just 13%, down from 20% (where it was on par with sales.)

So what does this tell us about Macy’s board? Here’s how the company described the importance of each of these measures in the preliminary proxy filed on March 19:

The EBIT measure focuses the executives on maximizing operating income and is a good indicator of how effectively the business plan, which focuses on growth in profits, is being executed. Top-line sales are a priority for retailers and are a measure of growth. Sales provide opportunities for the achievement of various other financial measures, including EBIT and cash flow. Cash flow is indicative of the manner in which the Company’s operating activities, together with its investing activities, actually generate cash. How a company increases its cash flow and then chooses to invest the cash are among the most important decisions management makes.

In other words, the board seems to be more concerned about increasing growth and opportunity through sales, and less concerned about increasing cash-flow and management’s business-plan execution.

There’s another oddity about Lundgren’s bonus formula: While scoring better on each of the three measures (EBIT, sales and cash-flow) snares him a progressively better bonus, the progression is far from smooth. If he increases sales by a tiny fraction (from 100% of target to 101% of target) his bonus shoots up by $900,000. That’s because hitting his sales target adds $750,000 to his bonus — while exceeding his sales target by 1 percentage point increases his bonus by $1.5 million. There was also a big step in the original contract at the same point — but the reward for that extra percentage point was half as big, at an incremental $450,000.

The bottom line? Lundgren now has more incentive than ever to boost sales — and in particular to reach that elusive 101%-of-target mark. And his incentive to hit his targets for operating income and cash-flow are smaller. That’s what the board seems to want — we’ll see if it satisfies shareholders.

Image source: alistairmcmillan via Flickr