Trends in Executive Compensation: Tying Rewards to Performance
Structuring competitive compensation packages for C-level executives has never been more difficult. Today, it’s commonplace for investors, customers, media and the government to demand transparency into a business’ performance and its leaders’ pay, especially when perceived as lucrative. As a result, more organizations are tying rewards to performance, and holding their executives accountable.
Beverly Morgan, WinterWyman Executive Search’s Senior Vice President and Partner, recently explored this and other executive compensation trends with several highly-regarded experts in the field: Jack Connell, Partner in Mercer’s Executive Compensation practice; Tom Wilson, President of the Wilson Group, a strategic consultancy focused on total compensation and rewards; and Susan Malanowski, a Principal of the Wilson Group.
Under the Microscope
Due to SEC regulations, online forums and social media, executive compensation has never been more publicly scrutinized. "Companies are aware of executive pay and how its viewed by the public," Wilson said. The pay ratio between senior leadership and front-line employees often makes its way into the media, with high disparities being portrayed as unfair if not exploitive.
More importantly, shareholders are pushing to link pay and performance, Connell said. Things like performance-based vesting don’t help when it comes to attracting and retaining top executives, he allowed, "but they’re good shareholder optics."
The equation has shifted in the last five to seven years, Connell said. "Before the crash, executives had the upper hand." That changed as the Great Recession caused shareholders and boards of directors to pay more attention to what, and how, their company’s leaders were being paid. The strict enforcement policies of Sarbanes-Oxley and its protections against fraudulent accounting practices also had a hand in "waking the boards up," as Connell put it. As a result, he said, companies now have the upper hand.
Today, more organizations are creating executive compensation packages that rely less on base pay and scheduled options and more on performance-based bonuses and longer vesting periods. On average, said Connell, they offer the marketplace’s median base and link rewards to the value the executive actually delivers. And even there, limits are at work. A CEO may be held to three or four times their base and bonus when it comes to receiving options or shares, while Senior VPs may be held to one or two times that amount.
At the same time, fewer companies are granting blanket exit clauses that allow an executive to leave—voluntarily or not—with a significant payout even if they haven’t lived up to expectations.
This emphasis on performance has become widespread across a range of industries as well as companies at different stages. For example, it’s never been surprising to hear that a startup tilts its offers to the rewards that go along with a successful IPO. However, executives at established companies may be caught off-guard when they find their compensation is tied to, say, the cost-savings their department achieves.
In addition, noted Wilson, a few companies are experimenting with a reverse incentive, namely the clawback, where executives surrender part of their compensation if they don’t achieve specific goals. Such an approach "has a stronger impact in terms of motivation," he said, adding that it also works against creating any sense of entitlement in the C-suite. Though clawbacks are rare, he said, "it’s interesting to see their impact on behavior."
Balancing Risks and Rewards
Even though performance is increasingly at the core of executive compensation, public companies often worry about the scarcity of talent, Wilson said. As a result, "they rush to the mean, which is a problem when you’re trying to get the best leaders." A better approach, he believes, is to understand the executive’s goals and balance the challenges they face with the value they offer.
Much depends on where an exec is in their career, Connell added. A successful leader exploring for a new role later in their career is more likely to be interested in a business challenge and less likely to be concerned about money than a younger executive looking for a high-income growth opportunity. Still others may want to protect what they have and are more interested in balance and incremental steps. Whatever the case, Malanowski believes, executives at this level "will be more individual in what they want, and they expect employers to understand that."
The emphasis on performance combined with the sophistication of senior-level executives means companies "have to personalize the compensation picture and be more flexible," Wilson said. "Internal compensation, like deferred compensation or shares, is rising in importance. The increases are being seen in bonus plans, not the base packages, and metrics drive a lot of those plans."
Hiring an executive is "all about impact," Wilson said. "It’s like hiring a third baseman. It’s not just about money, but also about time to market and performance."