Examining the Potential of New Executive Compensation Structures
Workspan Daily
June 07, 2022
Key Takeaways

  • Delivering a competitive advantage. It could behoove some public companies to borrow the structural differences from private equity-owned companies and incorporate them into their own pay models. 
  • Improving ROI. Some companies might benefit from discontinuing merit salary increases and instead focus on paying for performance via the incentive compensation arrangements.
  • Challenge the norms. If your business has changed, it could be time to consider going beyond your comfort zone, challenging the status quo, and changing your executive compensation program design and practices.

The core responsibility of designing compensation plans that attract, retain and motivate the right CEO and his/her executive team requires new levels of creativity and flexibility — more customization to each organization’s unique circumstances than ever before. 

We’ve all heard the expression “If it’s not broken, don’t fix it.” But even if something isn’t broken, it may not be functioning optimally. This certainly applies to executive compensation plans, which overall have become relatively stagnant. 

Done right, a compensation plan should serve to achieve competitive advantage and improve the return on investment in executive compensation. 

Delivering a Competitive Advantage

Some industries are seeing increased competition from businesses that are private equity (PE) owned and those PE-backed businesses often have pay models that significantly differ from publicly traded entities. Typically, the private equity pay model offers lower cash compensation but higher long-term, equity-based compensation. That long-term equity is often delivered via a one-time equity grant that is exclusively in stock options. 

Such a simple — but high risk/high reward — pay structure achieves the very important goal of aligning executive and shareholder interests, while also reducing the annual pay negotiation process over annual grant values, performance metrics, goal setting, etc.

I would argue that it is time for some public companies to borrow these structural differences from private equity and incorporate them into their own pay models. Particularly for public companies in transition, this approach can offer a streamlined way to structure compensation that allows for more focus on strategic direction. For example, companies that find themselves in turnaround situations could benefit from up-front equity grants as opposed to annual equity grants. This approach would also be beneficial for businesses that are stagnant or in decline.

The use of stock option-only rewards lets companies avoid the complexity of annually selecting metrics and setting multi-year performance goals. The additional benefit is that this approach makes it far easier for companies in industries that are regularly impacted by external factors, or that have a significant merger and acquisition component to their business strategy.

Improve Return on Investment

While all generally agree that paying for performance is the best way to maximize the return on investment for executive compensation, there are some common pay elements that surprisingly, may not live up to that standard. 

Take merit salary increases, for example. While base salary is a relatively small component of executive pay and is not performance-based, it often has a cascading impact on other pay elements such as bonus, equity grant values, severance, etc. Accordingly, some companies might benefit from discontinuing merit salary increases and instead focus on paying for performance via the incentive compensation arrangements.

Executive severance presents another potential anomaly. Large severance packages that were agreed to when attracting the executive can later become a shining example of paying for poor performance when exiting the executive. Since the premise of severance is to bridge an employment gap, perhaps some companies should limit severance to a multiple of salary and include mitigation. 

Another approach would be for severance benefits to decline over time once the initial risk and uncertainty of a new job diminishes and the executive has accumulated enough wealth to bridge their own employment gap.

Don’t Fear Challenging Norms

“That’s the way we’ve always done it” is no reason to continue practices that no longer serve your company. If we’ve learned anything over the past two years, it’s that things change. And change can be good. 

If your business has changed, maybe it’s the right time to consider going beyond your comfort zone, challenging the status quo, and changing your executive compensation program design and practices.

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Related WorldatWork Courses
Advanced Concepts in Executive Compensation
Executive Compensation Immersion Program