Recently, one of my VisionLink partners and I had a meeting with the managing director of a successful private equity firm. Part of our discussion was centered on the somewhat narrow view CEOs take of compensation; an issue that perplexed this business leader given the large deployment of capital payroll represents for most companies. "They seem to deal with pay issues in isolation, trying to determine--for example--how many options someone should have without considering the whole compensation picture," he mused. "They don't think about it strategically, which is a problem because businesses invest a lot of money in compensation."
My experience reinforces that characterization. Most corporate leaders think about compensation as an expense, not an investment. I suppose this happens, in part, because it's treated as such on the income statement--so most of the focus ends up being on how to contain it. In the CEO's view, the "cost" of compensation needs to be minimized.
There is a different (better) way to think about pay; an approach, in my view, the 21st century business environment will require all organizations to adopt if they want to fuel success and growth.
Pay is one of the largest deployments of capital a business will consistently make. It is an investment, not an expense. In that context, the series of plans a company considers offering should be looked at as indivdual parts of a comprehensive compensation "portfolio." There should likewise be an investment strategy statement for that portfolio (which we refer to as a pay philosophy or compensation constitution). The parts of the comprehensive whole are just like the asset classes one uses for personal investments. Effective compensation design is achieved when a balance of the right compensation components work in combination to achieve the "investment" objective of the investor (in this case, the business owner)--typically measured in terms of growth in shareholder value.
The pie chart below shows the various "asset classes" for compensation that business leaders should examine in determining what their pay allocation will look like. The combination of elements included in any one company's compensation portfolio will be driven by the outcomes it is trying achieve--which are, in turn, linked to the company's growth goals. Each classification should have a purpose and focus that is intended to drive a certain kind of result. The art of effective compensation investment allocation is determining which asset classes should be employed and how much weight each should be given.
To determine how best to apply this investment model to your organization, it is helpful to think in terms of planning principles. Success will rely on at least five guidelines:
- How you pay people is just as important as how much you pay them (if not more important). Each component of pay communicates something about the priorities of the organization. LIkewise, elements of pay that are not included also send a message. For example, if you have an annual bonus plan but no long-term value-sharing arrangement, people can only conclude that short-term results are most important.
- Value creation should lead to value sharing. Those who create value should share in the growth they help the company realize. The key is to define the point at which value creation occurs;when added value is being generated (see principle #3).
- Incentive plans (value sharing) should be self-financing. This means they are paid out of a productivity profit--the amount of net operating income available after a capital "charge" has been assessed to protect shareholder value. Value is only paid out of value that has been created.
- Rewards should be managed within a Total Compensation Structure. This means each specific pay program is monitored in the context of the whole portfolio and not as an individual compensation investment. When a decision is made about any one plan it is within the framework of its impact on the comprehensive compensation strategy.
- The return on the total compensation investment should be measured. There are various ways this can be done, but the intent is that you hold pay accountable for its contribution to shareholder growth as you would any other capital investment.
When business leaders begin considering compensation as an investment instead of an expense, they ultimately reach an "aha" moment. When that happens, pay is viewed as a strategic tool that enables growth for shareholders. It helps owners and CEOs align the workforce with the shareholder's vision of a future company and build a sense of partnership instead of entitlement. If approached properly, it should engender a unified financial vision for growing the business. When that occurs, you have an effective compensation investment portfolio.