A successful compensation program, one that drives strategic execution and competitiveness, starts with a guiding philosophy. That’s especially true of executive compensation. Just as companies develop different business strategies, they benefit from different compensation philosophies that respond to their unique circumstances.
The compensation philosophy should take into account three factors: business priorities, management style and organizational culture. As for priorities, the pay structure should fit the company’s financial realities and position in the business cycle. A pay plan that stresses payouts in equity might suit a cash-starved tech startup from the West Coast. A plan that suits a cash-rich consumer-goods maker in Cincinnati might stress more balanced pay elements. A plan stressing leveraged payouts over the long term might fit a turnaround in Boston. Are you an early-days Snap Inc., a Procter & Gamble Co. or a General Electric Co.?
As for management style, the degree of individual differentiation should fit the way the CEO likes to run teams and units. Does the boss insist on team play, all for one and one for all? Or is individual accountability more important? An individual focus works well for finance firms in New York. Group rewards might work for manufacturing firms in the Midwest. Are you a Morgan Stanley or a John Deere?
As for corporate culture, pay prominence should match executive ambitions. Does the executive team rally to the prospect of high-risk, hefty payouts? Or does it respond more to the challenge of company building, career advancement and the chance to “change the world.” Big, leveraged, prescriptive incentives turbocharge some executive teams. More predictable, even payouts in combination with other nonfinancial rewards gratify others. Are you a private equity portfolio company or an electric utility?
With the basics clarified, the philosophy also should include some specifics as to how the plan will work. How (and how much) will the company position pay compared to peers? Should the company peg pay at the median? Or will it pay executives at a higher level?
And how will the company focus executive efforts and rein-force business priorities? Which types of metrics will govern incentive payouts — a mix of financial and operational? What about strategic metrics? How rigorous will your targets be? How highly leveraged your payouts? Will your annual bonus be paid all in cash? Will your long-term incentive pay be paid out in stock, options or long-term cash?
And how much will you adjust your mix of pay elements (base salary, short-term incentives, long-term incentives) based on attracting and retaining talent (paying whatever it takes) or for performance (paying for delivery of results)? Will you lavish up-front cash and stock on rare tech gurus in an AI-driven economy? Or will you pay them in performance-based restricted stock after the new machine-learning-based business takes off? Finally, what are your stock ownership expectations? How much stock will executives have to hold to show they always have skin in the game?
Together, these philosophy components provide guideposts for designing and administering pay — and for communicating compensation plans’ focus to the outside world. Most companies revisit them annually and communicate them in the Compensation Discussion & Analysis. The philosophy is the foundation for building a strong executive compensation program that’s reflective of the company’s business priorities, management style and culture.