In this column, I have argued that most CEOs need to be more involved in providing leadership regarding the pay approach their company adopts. Pay is a strategic issue and strategy needs leadership. Therefore, rewards development must include direction from the organization’s primary business leader. That said, I have seen some CEOs carve out a compensation course that has been a negative instead of a positive influence on company growth. They instituted policies and programs where employee performance declined—or, at best, stayed neutral—and the growth trajectory of the business was impaired.
As a result, in today’s offering, I’d like to talk about how a chief executive can kill employee engagement through the pay strategies he encourages if he’s not careful. This happens when a business leader ignores proven principles and practices of compensation design that apply to any company, regardless of industry or size. When they aren’t followed, employees don’t feel they have the right kind of financial partnership with the company. As a result, their commitment and passion wanes and waivers.
Here are the four most common ways CEOs impair employee engagement with pay.
1. Employment of a Wrong or Incomplete Blend of Compensation Elements
In our experience at VisionLink, the biggest compensation mistake made by growth-oriented private companies is not striking an effective balance between short-term and long-term value sharing. Most often, organizations are focused short-term in their pay strategies and either ignore or dilute rewards for sustained performance. In a study VisionLink completed a few years ago of 139 companies with revenues between $250 million and $1 billion, the following observations were made:
- Top quartile companies placed a greater amount of compensation "at risk" - 66% vs 52%.
- Top quartile companies placed greater emphasis on long-term awards - 42% vs 33%.
Why is this important to consider? The right blend of compensation elements is essential to impacting three key outcomes that most growth-oriented companies need to achieve:
- Increased performance
- Meeting the "satisfaction quotient" (fulfilling both owner and employee objectives)
- Attracting and retaining premier talent
In addition to striking the right balance between short and long-term awards, companies must also make sure they have an effective and diversified blend of the following plan components: salary, bonus, long-term cash incentives, equity or phantom equity, retirement, core benefits and executive benefits. Those components, when properly employed in an organization’s compensation strategy, have a similar effect as asset classes that are used to develop a balanced investment portfolio. Each is important in creating an overall portfolio that maximizes return while minimizing or mitigating risk. Because this evaluation is critical but not always easy, many companies seek the help of outside professionals to assist them in this effort.
2. Offering Value Sharing Opportunities that Don't Result in Meaningful Payouts
If a pay strategy is going to positively impact performance, it must include a means for employees to participate in the value they help create. This means organizations must first identify a pay philosophy that strikes the right balance between guaranteed (salaries) and variable compensation (value sharing)—as just indicated. It needs to then determine how much value-sharing should be devoted to short-term performance and how much to long-term.
But the work doesn’t end there. Business leaders must subsequently engage in the hard work of developing incentive plan models that show what kind of value-sharing would be possible at various company and department performance levels—such as base, target and superior. These then need to be broken down further to address employee tiers or salary bands so an examination can be made whether the payouts at each level will be considered meaningful to those participating.
This kind of evaluation requires a combination of economic science and art. CEOs need to have a “sense” for what their key performers in particular will consider “fair” when it comes to the amount of value they should have a stake in. Certainly, market pay data can provide some guidance here, but chief executives make a mistake when they assume such data should drive their decision-making on incentive pay levels.
The balance you are seeking is to have compensation opportunities that are meaningful and motivational to the participants while being aligned with shareholder (financial, structural and organizational) goals and expectations. Although this balance is a little different in each company, some rules of thumb might be helpful. We have found the following to be fairly typical of effective growth-oriented companies:
Short-Term Value Sharing
20-60% of salary for executives
10-40% for 2nd tier managers
Long-Term Value Sharing (for key contributors)
40-80% of salary for executives
20-35% for 2nd tier managers
3. Setting Performance Requirements that are Out of Reach or Too Complicated
For compensation to have a positive impact on engagement, employees need to be able to say: "I can see precisely how my performance aligns with my pay!" Employees become frustrated or indifferent if they don't feel they can impact the results they have to achieve to realize the full potential of their rewards package, or if the metrics and measures associated with them are convoluted or too complicated to understand. This is usually where CEO frustration comes in as well. The chief executive feels as though his employees don't "get it" - and don't have the same passion about his vision that he does.
Ultimately, if employees don't feel they can actually impact the performance their compensation is tied to, there will be no positive return on the pay investment the company is making. Productivity profit—the amount of net operating income attributable to the productivity and performance of people and not just other assets at work in the business—will stagnate and decline. In short, you may award me stock—but if I don't feel my role and performance can influence the stock price, then my attitude and performance will reflect that.
4. Ineffectively Communicating and Reinforcing Rewards
Coaching and reinforcement are the keys to creating long-term focus and commitment in the organization. In this context, rewards are a means of reminding employees what is expected - but more importantly, why it's worth it to strive for that goal. Each rewards program becomes a kind of covenant between the employer and the employee. It defines an area of stewardship, establishes expectation levels for that area and provides a partnership context for their fulfillment. "If you own these outcomes, here's what it will mean to you."
Each element of compensation communicates and reinforces different aspects of performance that need to be achieved. And the degree to which those performance expectations and their associated rewards are communicated and promoted will in large measure determine whether or not the desired performance is attained. Ultimately, CEOs should insist on a rewards reinforcement strategy that consistently helps employees understand the relationship between the vision of the company, its business model and strategy, the employee’s role and what’s expected of him in that role, and how he’ll be rewarded for fulfilling those expectations. This is what is known as creating “line of sight” in an organization—and without it, there is no engagement.
Building a compensation strategy is not complicated but it is nuanced. It requires attention to these kinds of principles and details if it’s going to have a positive influence on employee commitment and passion. CEOs that put these principles into practice will see the quality of talent they are able to attract and retain will improve, employee engagement will expand, performance will be magnified, business growth will accelerate and shareholder value will increase. Not bad.