If you are the chief executive or president of a business, your time comes at a premium. As a result, it must always be applied toward activities that have a strategic impact. That’s why you surround yourself with “specialists” that can provide more granular leadership in areas that impact the organization’s ability to solve problems, create and deliver great products and meet its growth objectives. Because of this construct, most business leaders delegate the development and implementation of compensation plans to human resources. But this is changing and here’s why.
Compensation needs to be dealt with strategically in today’s environment, on a par with product development, marketing and business expansion. Why? Because your company’s pay strategy has broader strategic implications than ever before. It impacts everything from the ability of your organization to compete for the talent it needs to how your employer brand is perceived.
This is not to suggest that you need to be involved with every detail of your business’s rewards approach. But what it does mean is that you must provide strategic direction in realms no one else can. Your overarching guidance should influence how your company’s pay strategy is designed, communicated and managed. So what oversight should you provide and what should it address?
The 3 Purposes
There are three areas that require CEO leadership when it comes to creating a compensation offering that will have the strategic impact you want it to have. You are the one in the best position to provide guidance in these areas. In fact, it could be argued that you are the only one that can provide that direction.
1. Defining the job you need compensation to do.
Pay should be outcome focused. This means it should help provide clarity to employees about their roles and the results for which they are responsible. And it should help hold them accountable for achieving those results.
The concept of the “job to be done” comes from Clayton Christensen, the Harvard Business School professor who has driven much of the innovation and disruption discussion in our country. His concept is that when consumers purchase a product, they are doing so to perform a certain job they need done. If the product helps them do that job—and do it better than someone else’s product can—they will continue to purchase that product. If it doesn’t, they’ll create a workaround.
This principle should be applied to our business processes as well. A company should know what job it expects compensation to achieve for it. And the person who needs to define that is you—the chief business leader of the company; because you are the one best equipped to say what outcomes you expect your pay strategy to help your organization achieve. Stated another way, if you don’t know, who else could possible know?
Here are some examples of the kinds of outcomes you would likely want your rewards approach to help your business accomplish:
- Improve short and long-term profitability (increased revenue, improved margins, lower costs).
- Increase shareholder value.
- Accelerate innovation.
- Increase the caliber of talent the company is able to recruit and retain.
- Provide clarity about roles, expectations and outcomes.
- Encourage an ownership mindset on the part of employees.
- Link employee rewards to performance.
- Build a unified financial vision for growing the business.
Yes, your compensation strategy can and should help you achieve all of those things—and more. Conversely, if your pay approach is not constructed properly, it could restrict your ability to achieve those things. I’m not suggesting compensation is the only tool you have to bring about those kinds of results. But it is certainly one of them.
2. Defining what value creation means for your business.
Organizations need to be able to identify the point at which the profits they are driving are attributable to the performance of people employed in the business or simply other assets at work. Another way of looking at this is to think of it in terms of the return shareholder should be able to expect on their capital “account” before sharing value with anyone else via incentive plans. The rationale is that capital tied up in the business represents an opportunity cost to owners that has be accounted for in determining true value creation in the enterprise. Then it has to be determined how much of the “surplus” value the business creates should be shared with those who help produce it.
Here’s an example of what I mean. In 2005, Keith Williams took over the leadership role at Underwriters Laboratory (UL). At the time he joined UL, the 118-year-old company was mired in mediocrity. It had stagnated and wasn’t growing. Teams and divisions operated like silos, as though they were in competition with each other. Williams instituted several changes to remedy this including some for compensation. In the process, he served up a perfect example of what it means to define value and how to tie it to the company’s rewards system. Here is how the article about Williams in Chief Executive Magazine described it:
Williams also changed the compensation program to align everyone behind the company’s success. “I call it ‘pay the company first,’” he says. “Basically, up to the company’s operating profit target, all of the profits go to the company; and only after that target is met, do we start funding the incentive pool.” For example, if UL’s target is $80 million, 100 percent of the first $80 million in profit goes to the company, the next $20 million to the incentive pool, and from there on, funds are split 50/50 between the company and the incentive pool. “At a lot of companies, people think, ‘I’ve got $1 million left in my budget; I should spend it,’” says Williams. “What we’re saying is ‘If you really need to spend that $1 million on our future, please do, but if you don’t spend it, half will go into the incentive pool.’”
Note that this kind of direction is something only the chief executive of an organization can set. No one else would have the necessary insight or strategic perspective to provide this kind value creation insight and definition.
3. Defining the philosophy that will guide the company’s pay strategy.
A company’s pay strategy is only as effective as the philosophy that provides its foundation. In other words, organizations need to build their compensation offerings on a belief system. Such beliefs are tied to and grow out of how the company defines value creation. Given what we just discussed in this regard, it stands to reason then that the chief business leader of the company should establish the parameters of the organization’s pay philosophy. So, what does that mean exactly?
At a minimum, it means the CEO needs to establish how the company’s pay approach will be aligned with its overall strategy for company growth and talent development. The pay philosophy should reiterate the company’s value creation definition. It then establishes how value will be shared (once appropriate thresholds have been reached) and with whom. For example, a good philosophy statement will provide direction on the following:
- The balance the company will maintain between guaranteed income (salaries) and variable income (value sharing).
- The emphasis the organization will place on rewarding short-term versus long-term performance.
- Who will participate in short-term value-sharing and who in long-term plans.
- The conditions under which equity will be shared with employees.
- How merit pay increases will be determined.
Certainly, there is more that can go into a compensation philosophy statement. But hopefully you can see that it is essential that the primary business leader of the company set the direction for this statement. Certainly, others can have input and may even draft an initial broad structure for the company’s philosophy, but the chief executive must ultimately make the primary decisions about what this document says.
I can say with certainty that, in the organizations where the CEO is not involved in these three decisions, the pay strategy of the company suffers. Don’t let that happen to you. Don't make the pay mistakes that prevent prevent CEO success at your business. Instead, if you lead a company, get involved in making the strategic pay decisions that only you can make.