- Industry has been breaking with tradition. In recent years, the not-for-profit healthcare provider (HCP) sector has put more focus on variable pay to compete for executive talent.
- New ways have brought new challenges. Some not-for-profit HCP organizations have recently expressed concerns about challenges they are encountering with a leveraged approach to compensation.
- Plenty to consider when examining pay strategy. Many of these organizations have begun examining their current pay mix, assessing whether to reduce the amount of pay at risk. Those considering it should think carefully about several issues.
Historically, formal executive incentive plans were few and far between among not-for-profit healthcare provider (HCP) organizations. Executive compensation packages typically consisted of base salary, benefits, supplemental retirement and maybe a few perquisites.
Learn: Executive Compensation Immersion Program
However, a shift began in the 1980s and 1990s as HCPs found themselves increasingly competing with for-profit companies — both healthcare and general industry — for executive talent. Candidates from these for-profit sectors were familiar with and expected an element of performance-based pay with significant upside potential.
The competition for talent intensified after the 2008 recession, as numerous for-profit companies saw an opportunity to profit from entry into the HCP sector. However, many of those companies had no in-house HCP experience, so they began poaching executive talent from hospitals and health systems to help lead their new businesses. As a result, companies such as Amazon, CVS, Google and Walmart have entered — and, in some cases, exited — the HCP space.
As the competition continued to increase, the not-for-profit HCP sector expanded the definition of its competitive talent market to include for-profit and general-industry organizations in addition to traditional not-for-profit HCP peers. Correspondingly, the sector put more focus on variable pay — both short- and long-term incentives — to compete (though long-term incentives usually are used only by larger systems). The economics of the HCP sector also made leveraged pay (i.e., pay at risk) more attractive as external influences wreaked havoc with financial performance.
With this increased focus on leveraged pay came the tendency to target total cash compensation (TCC) and total direct compensation (TDC) above the median of the blended market, often at the 65th or 75th percentile. Despite targeting a higher percentile of a blended market, the degree of leverage in the not-for-profit HCP sector remains significantly below that of the for-profit sector. This is largely due to the lack of equity vehicles, which requires long-term incentives, if offered, to be paid in cash. Additionally, base salaries generally remain above those of the for-profit sector.
Recently, however, a variety of not-for-profit HCP organizations have expressed concerns about challenges they are encountering with a leveraged approach:
- Candidates are more focused on fixed pay rather than variable pay and tend to discount the value of potential incentive awards.
- The pandemic underscored the potential impact of a “black swan” event on executive compensation through no fault of the executive team. Many compensation committees appropriately exercised discretion when evaluating performance against incentive metrics during this time. However, the inability to control the outcome can be frustrating for executives, causing them to further discount the perceived value of incentives.
- Significant structural changes across the HCP sector along with historical variables (e.g., Centers for Medicare and Medicaid reimbursement levels) present a challenge when establishing incentive metrics. This is particularly true of long-term incentives that, absent equity vehicles, require the establishment of performance metrics that extend several years into the future.
Pay at Risk, or No Pay at Risk? That Is the Question
As a result of these challenges, many organizations have begun examining their current pay mix, assessing whether to reduce the amount of pay at risk. This is a significant philosophical debate, and organizations considering it should think carefully about several issues:
- Has the underlying belief about whether pay should be strongly linked to performance changed? What message does deleveraging send to executives?
- If the degree of leverage is reduced, should the organization target TDC at a lower percentile (e.g., the 50th percentile vs. the 65th or 75th percentile)? Market-pay levels generally increase with the degree of leverage, effectively applying a risk premium to pay that is heavily leveraged.
- Is the organization still competing with the for-profit sector for executive talent? Generally, the executive pay package risk profile should approximate the talent market risk profile.
- If incentives are significantly reduced or eliminated, how will organizations manage and reward performance? Does the organization have another means for performance management — and/or for differentiating pay?
- If incentives are reduced but not eliminated, what is the appropriate reduction degree? Will the remaining award opportunities still be meaningful?
- Is the recruiting challenge a generational issue (e.g., is Generation X more risk averse as it enters the executive ranks)? Or, is the recruiting challenge a reflection of candidates’ negotiating power because of the current talent shortage (i.e., there are fewer Gen Xers than Baby Boomers)? Is it both? Will the need to deleverage still exist in a recessionary economy?
- Is it important to be able to bring back leverage in the future? If so, how does that affect the degree to which you deleverage today? Will base-salary increases need to be held back for a period to allow for incentive reintroduction?
Take a Big-Picture View
There is no absolute right or wrong answer to the question of whether to change the degree of leverage in your executive compensation program. However, the resulting program should align with the organization’s compensation philosophy, guided by its responses to the questions in this article.
Increasing the base salary target alone will not result in a significant decrease in leverage, though it may make base salaries more attractive to candidates (and current incumbents). If incentives are reduced or eliminated and pay becomes less leveraged, however, the organization should consider whether targeting pay above median remains appropriate, whether the message being sent to executives is what is intended and how performance will be effectively managed going forward.
Editor’s Note: Additional Content
For more information and resources related to this article, see the pages below, which offer quick access to all WorldatWork content on these topics:
