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When a company experiences a decline in its financial numbers, the finger is often pointed at the easiest culprit: the compensation plan. The “plan” lacks the motivational effect desired, or the plan does not focus attention on desired behaviors; or the plan isn’t retaining the company’s key people. So you consider a redesign. But putting a new plan in place doesn’t necessarily guarantee it will work any better than its predecessor. Often, the plan is developed with little time, foresight, analyses or attention on the key issues that can significantly impact the ability of the plan to succeed. The fact is, plan mechanics aren’t usually to blame for the plan’s malfunction; there are inherently internal issues that affect the ability of the plan to focus attentionon the right activities. The problems typically fall into three main categories: 1. Overly Complex Plan Design. If you want to guarantee the demise of executive compensation plan, make it difficult to understand. Plan “designers” often tend to try to accomplish too much within the plan in order to satisfy all of the parties involved, but the irony is they end up not serving any aspect of the business very well. Or they try to address every possible performance scenario and put in so many caveats that it leaves heads spinning. To alleviate this issue, follow the “KISS” adage – Keep It Simple, Stupid! 2. Administration Gridlock. When plans are overly complex, they can be very difficult to administer on a timely basis. Often, the complexity also adds an element of ambiguity, because it is difficult to define all the scenarios and caveats of a plan when you’re are dealing with a multitude of layers and too many variables. When administration becomes difficult, plan participants can begin to question the plan’s administrators - and ultimately lose faith in the plan itself. 3. Unclear Goals. When an executive compensation plan is too complex and hard to understand, it become even more difficult to explain to the participants - the executive loses focus (since they cannot understand the plan or what the company really wants) and, in effect, their motivation is reduced. Many companies devote considerable time and resources to developing compensation plans, then fail to educate their executives about their compensation plans or adequately communicate their goals and objectives. As a result, the company may find that the executive are unable or unwilling to meet the performance metrics set forth by the plan, so they continue on a course that doesn’t reflect the appropriate business direction or realities. A Systematic Approach To avoid the need to continually reexamine the executive compensation plan, it is important to dissect the plan (and its inherent problems) in order to attempt to develop one that really works. Using a systematic process for assessment, design and administration will help to eliminate some or all of these issues and help you implement an executive pay plan that will be far more effective at meeting your company’s goals. The following six-step process may be followed for a systematic approach to plan design: Step 1: Clarify the Company’s Strategic Business Plan It is not unusual for a company to attempt to design a new compensation plan without having a consensus among the Board and top management as to where their focus should be, which performance goals to emphasize, and (in some cases) what the role of the executive should be. In order for the plan to be effective, these focus items must be identified and prioritized. This strategy should be used in defining the concepts for the new pay plan. Step 2: Determine the Desired Mix The design of the executive compensation plan should begin with a determination of what the reasonable and appropriate compensation package is for the company’s executive positions. This should be based on reliable market data from the company’s peers and industry segment(s) against which the organization measures itself. In addition, the degree of variability should be defined – that is, what will be the mix between fixed pay (salary) and variable elements (consisting of short- and long-term incentives)? For public companies, the mix tends to be more heavily weighted toward variable compensation, (including the use of stock-based awards), since equity is readily available, although the nature of the awards is shifting from stock options to restricted stock units, restricted stock, stock appreciation rights, and other programs. For privately held firms, the emphasis is typically on cash-based capital accumulation, however, many private companies are realizing the importance of some form of equity compensation within the compensation package in order to compete with their public counterparts. Once the compensation package mix is determined, the company should decide on its intended Executive Compensation Philosophy, which will serve as the reference point for evaluating the current program and designing the new pay program.
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