Choosing the right executive pay mix

The availability of talent in the market for a particular role determines the intensity of the war that is waged. When the right people with the right skills are plentiful, organisations do not worry much about losing particular individuals, as the task of replacing would not be as hard as when the supply is scarce.

In instances of scarcity of talent, organisations try all tricks in the book to attract and retain the limited number of people that are available. Such much-needed employees would be showered with generous remuneration, which would ordinarily include scarcity allowances, among other benefits and perquisites.

In our economy, the skills to perform lower level administrative roles and other routine tasks are a dime a dozen. Literally, when one throws a stone in a major city, there is a high probability that it would land on an unemployed person with the right skills to be appointed as an administrative officer. The same cannot be said of talent that is required to fill executive complex roles that are required to take organisations on a much-needed turnaround in the aftermath of the economic decline.

The battle for boardroom skills is much intensified by the void left by the exodus of intellectuals during what has come to be known as the lost decade.
Remuneration is one of the major reasons why people join or leave organisations, as it is the payment for their skills and effort which they put at the disposal of the organisation. Entities compete on the remuneration terrain by spying on what their competition are paying for talent.

 

Human capital professionals are relentlessly looking for this much-needed information. However, little data is readily available about rewards for executive roles. This is because among other facts, there are naturally few executive roles compared to other roles, and that organisations are not always keen to share this sensitive information, save for instances when regulations force them to do so.

It is, however, important to note that the relative size and complexity of jobs at executive levels are vastly different among organisations as influenced by each one’s size and industry sector. Homogeneity of roles at an executive level does not exist as it does for junior roles, therefore, homogeneity of remuneration may also not apply through straight benchmarking.

 

We will briefly discuss different elements of executive remuneration before making a generic recommendation for executive pay mix structuring. In short, there are four primary remuneration instruments that are used at an executive level, ie base (basic) salary, benefits and perquisites, short incentives (bonuses) and long-term incentives.

Basic salary is the component of pay that most organisations focus on first. It represents a fixed cost and an ongoing obligation. Once set, it is usually a cumbersome process to lower it; organisations have to tread carefully. It is important to recognise that basic salary can end up being the smallest component of compensating an organisation’s executive team.

To the executive employee, basic salary represents cash necessary to pay for standard of living obligations. It needs to be just large enough to permit the executive to maintain their sense of worth to themselves and their family. In turn-around organisations and start-ups, basic salary would be lower than in organisations that are established.

If an organisation is recruiting executives out of larger, more mature companies, basic salary will be larger than what turnaround or start-up organisations can afford. The turn-around or start-up organisation would be in a better place to offer the candidate less basic pay but offer better short-term or long term benefits, which can trigger an executive’s entrepreneurial spirit.

Generic benchmarking should be set aside because the actual level of basic salary offered should be comparable to like positions in similar start-up companies that are in the same industry, geographical location or have similar past performance. An organisation should tie the level of top team basic salaries to the level of responsibilities of the executives and their direct impact on the business plan. Those executives that directly affect the success of the company should be paid more.

Short-term incentives are principally cash-based payments which are designed to reward individual, or sometimes team performance above a standard over a set historical period, usually a year, although sometimes there is a partial deferral for a further period. Short-term incentives clarify and sharpen an executive employee’s attention to doing everything possible to continue on the road to business success. Usually, short-term incentives are paid in cash, or can be deferred. The major difference between basic pay and short-term incentives is that with the latter, if performance expectations are not met, it will not involve any outlay of cash. The downside is that if executives do not meet the objectives, the organisation may not be in business for long.

Organisations should design short-term incentives around attainable objectives. In turn-around and start-up companies where product development, production and customers are the key criteria for long term success, these should be critical milestones for short-term incentives. In organisations at the inception or regeneration stage, it would be prudent to set  objectives in terms of critical dates and key developmental milestones.

In instances where organisations need to conserve cash, a differed short-term incentive can be structured.  A good way to preserve cash and defer payment of bonus is to allow the executives to convert the cash equivalent of the short-term incentive into restricted shares. A deferred short-term incentive or a conversion to restricted shares ordinarily helps to focus the executive employee’s attention on the long-term success of the organisation, helping retain their talent.

Long-term incentives are often shares  or share-linked payments spread over a number of years, hence are intended to align the interests of shareholders and the executive employees. They are targeted at providing some form of retention incentive to ensure sustainability and continuity in leadership of the enterprise. Recently, particularly in the US, long-term incentives have been subject to total or partial performance conditions because of risk management, highlighted by the suspected role of incentives in precipitating the sub-prime lending bubble and the credit crisis that followed.

Long-term incentives are designed to trigger an entrepreneurial spirit in the executive team. These can tie the hands of the executive employees to the long-term success of the organisation and satisfy the executive’s desire to retire on a beach in the Maldives, or some equally exotic place. The best part of long-term incentives is that organisations can have an astounding advantage for every dollar they spend. Long-term compensation is usually in the form of shares. In unlisted organisations, a phantom share plan will probably be required.

Long-term compensation helps to retain executive employees and focus them on managing the organisation for long-term success. In larger organisations it is formula-driven, based on a shareholder return objective, such as return on investment, return on sales, return on cash employed. In turn-around and start-up organisations there may be no return to measure.

 

In such instances, it would be best to develop objectives based on the milestones that are to be achieved. An organisation would grant shares based on meeting the required milestones in the business plan. Each time the organisation reaches a milestone, additional shares would be granted. In addition, the organisation would set a vesting schedule for a number of years in the future, such that the organisation has sufficient time to achieve growth and profitability.

Of all the elements of executive remuneration, long term incentives are an area in which turn-around and start-up companies can be generous. In comparison to a low basic salary and short-term incentives, long-term incentives should be high in the fledgling organisations. Although share- based long-term incentives are not without cost to the company, they are currently by far the most inexpensive way to reward executive employees for their efforts, making up for lower than normal base and bonus compensation.

Turn-around and start-up organisations should tie the award of shares with the prudent caveats. They should vest based on the expected achievement of the milestones or other objectives established, and the granting of shares should be accelerated if the milestones or other objectives are met ahead of time. Organisations should plan to allocate up to a reasonable portion of their shares to their executive team, as this would permit sufficient ownership to capture their hearts, minds and souls.

In designing executive employees’ benefits and perquisites, organisations could give their top team vehicles, golf club membership and other benefits. Turn-around and start-up organisations do not necessarily afford these, but the reality is that our market is awash with them, so they cannot be ignored.  The advantage of these additions to a remuneration package is low on the scale of importance, thus organisations should do only what is necessary.

The ideal executive reward mix for turn-around and start-up organisations as compared to other organisations at different growth stages is shown in the table.

Getting executive reward correct should be approached based on proper organisational analysis. Straight benchmarking does not always give good results in the long term.

 

Sam Hlabati specialises in Systems Thinking and Reward Management. You can contact him on samhlabati@gmail.com

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