Pick up any newspaper or magazine today and you’re likely to find coverage of the ongoing controversy surrounding executive compensation. Outsized pay packages, particularly for corporate leaders whose companies have produced sub-par results (or worse), have attracted increased scrutiny in recent years. In part, this stems from the absolute size of these awards, and as taxpayer funds have become involved, political considerations are also in play.
For small and mid-size company CEOs, outrageous pay packages are rarely seen, whether ownership is public or private (see ExpertCEO salary survey for sample results). Nonetheless, intense review of these compensation programs is commonplace in today’s weak economic environment, so it’s worth reviewing the two key objectives when considering the size and composition of any senior executive’s pay package: motivation and retention.
For some sound, timeless advice, I return to George Von Gehr’s new book, “The Effective Entrepreneur: Fifty-nine rules to Create Value Throughout the Life Cycle of Your Company” (Amazon link) and, with permission, reprint here Rule 16. (see my blog dated 2/11/09 for George’s background)
“Many sources provide reference information on cash compensation at different organizational levels. When designing incentive compensation, the difficult issues for consideration swirl around these factors:
· Cash or stock
· Mechanism determining payout
· Payout timing
· Provisions for change of control
Any individual’s incentive program must be consistent with those of the other members of the executive group; there must be “parity” or balance across the group based on responsibility, experience, performance requirements, and total payout. Compensation must be competitive but not excessive. Consider the $100 million plus programs of Grasso (NYSE), Quattrone (CSFB), and Nardelli (NYSE:HD). Litigation may often follow. (KR note – add AIG, Merrill Lynch to the list).
Designing cash incentives involves two time-lines: twelve-month horizons that increase motivation and multi-year – usually three year – horizons that encourage retention. In either case, each executive’s incentive program should have at least two parts to the payout. The first part must be designed around the executive’s specific objectives – both qualitative and quantitative – of motivating achievement of individual targets. The second part should reflect corporate targets to foster teamwork and long-term retention.
Ordinary stock options vest over time and are assumed to be strong retention devices. They may represent a poor program for the company however, because the executive gains stock rights, regardless of the executive’s performance. It may be useful to custom design options in such that they have a second vesting standard tied to long-term company performance goals and / or to the recipient’s objectives. The recipient’s benefits are received only with both the running of time and the achievement of specified targets. Also keep in mind that some employees value options more than others do (usually higher management levels), and so indiscriminate distribution throughout the company may make little sense.
Sales compensation is a much-debated area. The only caveat here is, whatever scheme is put in place, the sales people will push it to extreme limits, so evaluate the structure carefully and anticipate all outcomes. Place caps on unlimited payouts. (KR note: caps on payouts are always contentious issues with sales people but extremely large payouts, at least in technology companies, usually involve unique circumstances and need to be treated as special cases).
In acquisitions, company executives may be asked to negotiate and complete a transaction in which they receive little or nothing for their stock; by this I mean those acquisitions in which the consideration is less than the preferred liquidation preference. Under these conditions, the board should provide a motivational incentive – usually a percentage of the price paid to the shareholders – as a carve-out before shareholder distributions.”
So how should CEOs, compensation committees, and boards structure pay programs to achieve their motivation and retention objectives, while avoiding perverse incentives and criticism from other constituents? In my experience, several relatively straightforward tasks can increase the likelihood of success:
1) Collect current, relevant data on salary, bonus, equity and commission plans. You may not always match the competition, but you’ll avoid unintended insults/attrition.
2) Understand your company’s capacity—cash-strapped but equity-rich? Try to attract key hires whose personal objectives match your resources.
3) Assume employees will compare notes; be prepared to explain your decisions.
4) Keep both long-term and short-term in mind. Create company-wide, as well as individual targets.
5) Communicate clearly, and in writing, goals and the way compensation is related to those goals.
Use experts when appropriate—a good attorney who specialized in compensation matters can more than pay for themselves with practical advice. Consultants who focus on compensation and who may have benchmark results (ex: Advanced HR, Radford) are also valuable contacts. Confer with peers by joining in on relevant discussions on ExpertCEO. Not a member? Go to ExpertCEO and apply to join today.