Executive Compensation: Getting Philosophical
[EDITOR’S NOTE: This post, co-authored by Ken Wechsler and Alexander Cwirko-Godycki of Radford, an Aon Hewitt Company (www.radford.com), is the first in a series of articles for Vistage focused on executive compensation. Over the course of the next several weeks and months, we’ll explore a number of compensation-related topics, including pay-for-performance, pre-IPO compensation planning, corporate governance, compensation philosophy implementation, and incentive plan design. This post borrows some content from work previously produced by Radford.]
When designing compensation programs for executives (or the general employee population for that matter), one of the first items to consider is your compensation philosophy.
Compensation philosophies serve as a foundation for establishing pay practices. They also provide frameworks for how pay is allocated across incentive vehicles and set relative to the marketplace.
Furthermore, as a company grows and begins to accelerate hiring, compensation philosophies can become an important asset when attracting and retaining talent. In addition to helping streamline pay-setting decisions for hiring managers and human resources teams, firms with well-established and easily communicated core compensation values are more likely to gain a reputation for innovative compensation programs, fairness and consistency in their pay practices, and as employers who value and reward their employees.
To get started with your compensation philosophy, the first item of business is to ignore the boilerplate language commonly found in public disclosures. In our experience, what you typically read in proxy statements only scratches the surface of the efforts made by management teams, human resource departments and boards of directors to develop strategic approaches to compensation. Simply copying and pasting from others won’t allow your company to differentiate itself in the market, and often won’t produce a realistic result against the specific strengths and constraints of your business.
With this in mind, Radford encourages clients to avoid a “one size fits all” approach when writing their compensation philosophies. Rather, companies should take time to carefully develop a philosophy based on existing values and cultural norms within the firm. Consider this: While it typically makes sense to target market practices for most elements of pay, your company will likely have one or two areas where you intentionally decide to behave differently than everyone else. For example, if you want to drive an outstanding ownership culture, providing above-market employee stock purchase plan (ESPP) features could make sense. Similarly, providing below-market base salaries could align well with a strategy of awarding larger stock option grants in the drive toward an initial public offering (IPO).
For companies developing a compensation philosophy from the ground up, we often suggest an approach that’s based on asking questions ― starting with the ten questions outlined below. These questions, intended to spark discussion, should be shared across both your senior leadership team and with the board of directors.
Furthermore, it often makes sense to allot time for separate discussions on key employee cohorts within your organization, as the answers to each question may vary based on the group under consideration. For example, your approach to compensating highly sought-after applications engineers or key international executives in China may differ significantly from other employees.
Compensation Philosophy Development Questions
- What are some of the core values you want your compensation philosophy to support? (Teamwork, fast decision making, flexibility, action orientation, process orientation, work-life balance, etc.)
- What behaviors and outcomes do you believe each element of pay (salary, bonus, equity, etc.) is intended to support?
- To whom do you compare yourselves in the marketplace? To what extent do you want to match their offerings? Relative to your peers, what areas of strength you can leverage?
- Do you recruit locally, nationally or globally?
- How should compensation programs vary — by job level, function or region?
- Compared to equity, how important has cash compensation been in recruiting and retaining executives and key employees? How do you feel this might change over time?
- Where do you want to position each element of pay for executives and key employees relative to your peers or industry (25th percentile, 50th percentile, 75th percentile, etc.)? Do you have a clear plan for how to communicate why each element of pay is positioned as it is?
a. Base salary
b. Annual incentive plan targets
c. Long-term incentives (cash and/or equity)
d. Target total direct compensation (cash plus equity)
f. Career development/training
- How might the positioning of each pay element vary for top performers, rising stars and key contributors?
- How important are the principals of egalitarianism or internal pay equity to your culture?
- Beyond traditional forms of cash and equity compensation, what other benefits do you believe are critically important to the company you intend to build? (Health and wellness, career development, etc.)
Naturally, the process of establishing a compensation philosophy is an iterative one. While core values, unique benefits and special cultural elements may stand the test of time, as companies grow, their approach to compensation often changes. For example, private companies contemplating an IPO frequently make substantial changes to their pay programs ahead of going public. Furthermore, mergers, new product lines (bringing on new types of employees), competitive challenges or the rapidly evolving corporate governance environment can all prompt revisions to your pay programs.
As a result, many companies review their compensation philosophy on an annual basis –- not necessarily with the goal of making dramatic changes each year, but as a check to ensure their overall approach to compensation does not lag behind the market. Over time, one would hope that a company’s compensation philosophy becomes a key aspect of its corporate character and mindset. Like a product roadmap, it should become the firm’s total rewards roadmap and align with overall strategy.
Ken Wechsler is based in San Diego and is Radford’s Southern California practice lead. Alexander Cwirko-Godycki is a senior research consultant based in Radford’s San Francisco office. Radford, an Aon Hewitt Company, is a leading compensation survey and consulting firm focused on the high-technology and Life Sciences sectors.