5 Keys to Effective Executive Compensation

A properly crafted executive compensation plan not only ensures you attract and retain the talent your business requires, it also effectively aligns the incentives for your executive team to the strategy and priorities of the organization.

The research for our annual CEO & Senior Executive Compensation Report for Private Companies shows that companies that prioritize structuring and implementing comprehensive executive compensation plans have better revenue growth and profitability than companies that do not.

An executive compensation plan needs to be thoughtfully prepared to ensure both short- and long-term goals are considered. These 6 keys below will help your company to properly implement effective executive compensation strategies.

1. Use Metrics as the Basis for Incentive Compensation

A common mistake for many incentive-based compensation plans is that they are not tied to specific performance metrics or goals. Discretionary bonuses provide the most flexibility. And there can be a discretionary component of an effective executive compensation plan, since not all objectives or situations may have been considered when the plan was set up. However, having short- and/or long- term incentives that are entirely discretionary is a missed opportunity to articulate clear individual and/or team goals and priorities to each of your executives. When there are specific formulas for bonuses and/or equity incentives, it aligns the executives’ focus and rewards those who deliver the desired results.

A best practice in setting goals and incentives is that they should be tied to metrics that each executive can influence or control (e.g. achieving profit goals for a divisional president or country manager, sales growth or revenue contribution dollar targets for a CMO or CSO, or recruiting success or employee alignment scores for a head of HR) vs. only corporate goals—and they should be SMART goals: specific, measurable, attainable, relevant and time-bound. This way, executives are aware of what they must focus on and they can optimize their work to achieve those specific goals. Sometimes macro metrics—like revenue and profit—are applicable, but, more often, there are better key performance indicators (KPIs) that should be used for executives who are responsible for a specific function vs. the overall business.

2. Effectively Communicate to Ensure Understanding

Another common mistake companies make is assuming that compensation plans are well understood by the executives. In reality, there often are huge communication gaps. Make sure every executive is fully aware of all of the components related to their compensation package, including the value of each of the benefits and perquisites they enjoy. And quantify the value and/or cost of these benefits and perks regularly—at least annually.

Often, executives take those benefits and perks such as health insurance or 401(k) matches for granted, unless the company quantifies what these other elements of the compensation plan are worth to them on a regular basis. Another common mistake is not communicating the value of any equity or long-term incentives on a regular basis as part of the compensation plan. Even if your company doesn’t have a formal annual valuation of the company’s equity, you can still give an estimate or illustrations of what their equity or long-term incentives may have increased by as part of the growth of the revenues and/or profit of the business. If you haven’t done a formal valuation, make sure you are explicit that your estimates are just that and aren’t binding.

If an executive does not have a clear picture of the total value of their compensation plan in their current position, the likelihood of looking for opportunities with more clarity of the upside is increased. Uncertainty is almost always bad for business, and this is a case where uncertainty on the part of a core team member can have unforeseen deleterious effects on a business.

Progress on a compensation plan should be addressed at least annually, outlining both short-term and long-term incentives. An even better idea is for quarterly communication—where the core metrics to which incentives are tied are discussed. This prevents any miscommunication prior to when the rewards are issued and help keep the employee motivated and aligned.

3. Benchmark Compensation Levels

If you’re trying to attract top talent, your compensation needs to be competitive, not just in your local market. Executive talent is portable—senior executives often do relocate for better opportunities.

Use external benchmarks from an independent third-party data source such as Chief Executive Group’s CEO and Senior Executive Compensation in Private Companies Report (www.ChiefExecutive.net/compreport) or a reputable executive compensation consultant who has access to a rich database of comparably sized companies in your industry, geography and situation.

In our research, companies often believe they are paying near the top-end of the spectrum for each of their executives when, in reality, they are at or below the median compensation level vs. similar companies who are competing for your talent.

Make sure the benchmarks you use are meaningful and relevant to your company. Use multiple reference points to compare your company and each position (for example, by revenue, industry, region and revenue growth) and look at quartiles, not just averages, to give you a much clearer idea of how competitive your compensation levels are.

4. Value Company Equity Regularly

In our research, more than half of the executives we surveyed do not have a clear idea of what their equity or other long-term incentives are worth, or how much they have increased in the past year. That is a huge waste of an expensive incentive, because most executives do not value what they can’t quantify. By granting equity-linked compensation but not tying it to any quantified value, you’re company is not getting the desired benefit of this long term incentive. And executives are not getting the positive reinforcement that they are benefiting from the increasing value of the enterprise or seeing the link with their efforts. In fact, many executives become skeptical or cynical of the value of their long-term incentives when they don’t get regular updates on the growth of their equity ownership.

If you plan on issuing equity-linked incentives, your company’s equity value should be appraised or estimated at least annually. At regular intervals (quarterly, annually, etc.), each executive should be told the estimated current value of their equity-linked incentives, as well as the expected future value.

5. Include Both Short and Long-Term Incentives

Providing a truly competitive executive compensation package usually requires that your executive team has both short- and long-term goals from which they benefit financially should their goals be met. A blend of incentive compensation that provides executives with cash incentives in the short-term tied to their achieving their specific goals and longer-term incentives—which in turn ties an executive to the overall success of the company—can help ensure your executive team is engaged and feeling rewarded for their hard work regularly.

Implementing an effective executive compensation plan does not have to be onerous, but it requires time, planning and dedication for it to work properly. We created our CEO & Senior Executive Compensation Report for Private Companies to provide businesses and their leaders with both benchmarks and best practices for their executive team.

To learn more please visit: www.chiefexecutive.net/compreport