Designing of Executive Compensation Plans - That Actually Drives the Performance?

Designing of Executive Compensation Plans - That Actually Drives the Performance?

  July 30, 2021    Nadun Abeywickrama

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Designing of Executive Compensation Plans - That actually drives the Performance?

Executive compensation can have a big impact on an organization. When compensation is managed carefully, it lines up people’s conduct with the company’s plan and creates better performance. If it’s achieved poorly, the effects can be shocking, the loss of key talent, demotivation, misaligned purposes.

As organizations work their way through the Covid 19-related economic crisis, many companies, for instance, have cut pay for senior executives. Extra pressing will be how to think about the goals implanted within incentive plans. Numerous targets won’t be attainable given the new financial realities and thus will no longer serve as effective incentives.

The relationship between executive compensation and firm performance, is yet to be completely understood (Mehran, 1995). Jensen and Murphy (1990) claimed that equity-based rather than cash compensation presents managers with the correct incentive to maximize firm value.

As per the FW Cook, 83% of the 250 major S&P 500 companies use a prescribed annual incentive plan, A good compensation system always begins with an organization’s strategic goals. Misaligned compensation is with them, worry ensues.

Figure from https://slideplayer.com/slide/6845883/

HR's Role

Designing and managing an executive compensation program is diverse. The most basic role an HR professional plays is being in a position to inform management of the benefits, costs and range of options in launching or improving an executive compensation plan.

HR professionals are key in determining what in-house and outside expertise is necessary and sufficient to handle an executive compensation program. Every organization needs some sort of outside proficiency for the design and management of an effective executive compensation program.

The failure of various executive compensation programs can be linked to

• Failure to obtain staff input in plans that will essentially incentivize executive performance.
• Failure to clearly express performance goals up front.
• Failure to state performance goals that are within the scope of influence of the target employee.
• Measuring staff performance according to values that were not stated in written documentation.
• Provided that job descriptions that do not implied the objectives set forth in the executive compensation plan

                                     (Source: Shampine, 2016 available in www.youtube.com)

Plan Design

Making an effective executive compensation plan requires organizations to balance stockholder alignment, performance-based pay, hiring and retaining, and the calculation of cost versus perceived value. A long-term reward plan with performance-based incentive vehicles can help accomplish that equilibrium.

Present trends in executive compensation:

• A higher percentage of executive pay is linked to performance.
• Pay incentives are more intensive on long-term outcomes.
• Companies have reduced on privileges for executives.

References

Bennett, B., et al (2015). Compensation goals and firm performance. Retrieved from Available at <http://apps.olin.wustl.edu/faculty/Gopalan/15_Compensation%20Goals%20Firm%20Performance.pdf>  (Accessed on 30 July 2021)  

Center on Executive Compensation. (n.d.) Basics of executive compensation. Available at <http://www.execcomp.org/Basics/Basic/What-Is-Executive-Compensation>  (Accessed on 30 July 2021)

Groysberg, B., et al (2021) Principles for designing executive pay     Available at <https://hbr.org/topic/compensation> (Accessed on 30 July 2021)

Jensen, M., and Murphy, K., (1990). Performance pays and top management incentives. Journal of Political Economy, (98): 225-264.  Available at <https://leeds-faculty.colorado.edu/bhagat/Jensen-Murphy.pdf> (Accessed on 30 July 2021)

Lytle, T. (2013). Agenda: Compensation linking executive pay to performance. HR Magazine. Available at from <https://www.shrm.org/hr-today/news/hr-magazine/pages/0913-say-on-pay.aspx> (Accessed on 30 July 2021) 

Mehran, H., (1995). Executive compensation, ownership, and firm performance. Journal of Financial Economics, (38): 163-184. Available at <https://www.sciencedirect.com/science/article/abs/pii/0304405X9400809F>  (Accessed on 30 July 2021)