CEOs are (typically) smart people. I mean, let's face it. You aren’t hired to run a company if you don’t possess strategic, managerial and leadership skills that can positively impact business growth and improve shareholder value and return. As a result, it is perplexing to see the simple yet highly consequential mistakes so many chief executives make when it comes to compensation. Here are the five most common “unforced” errors I see committed.
1. Not establishing a pay philosophy. Most clients our firm ends up working with have a history of developing their compensation strategies in a bit of an ad hoc fashion. Decisions about plan structure, eligibility, metrics and payout levels are divorced from any core philosophy that should guide a pay design process. A compensation philosophy statement should be the starting point for developing a comprehensive pay approach—one that results in a unified financial vision for growing the business. A good philosophy statement will define how value creation is defined for that company and under what circumstances it is shared—as well as with whom. It will also spell out the organization’s belief about how guaranteed and variable compensation should be balanced. It will articulate how much emphasis should be placed on short-term versus long-term value-sharing. A compensation philosophy statement is a kind of pay constitution that should guide all leadership’s decisions about a company’s pay programs.
2. Paying incentives instead of value sharing. Most studies in recent years indicate that incentive plans don’t “work” for motivating employee performance. Despite that evidence, we find many company leaders still construct bonus plans and other variable pay programs that incorporate a “carrot and stick” approach: “If you will do this, we will pay you that.” Value sharing is rooted in a different philosophy. Its core premise is that value should be shared with those who help create it. Its success depends upon a model that clearly defines the value creation threshold beyond which profits are attributable to the productivity and performance of employees, not just to other capital already at work in the business. Where incentives rely on a “force” approach (“do this if you want to get that”), value sharing relies on a “reinforce” approach (“here are the outcomes for which you have stewardship and the value that will be created and shared if you help us achieve those results).
3. Not measuring ROI on pay. Many CEOs treat compensation as an expense that needs to be contained instead of as an investment that needs to be properly allocated. As a result, they don’t measure their return pay as they would any other business investment. Every pay plan should have a purpose and a means of performance measurement. This is most easily achieved by determining the productivity profit of the business and dividing it by the company’s total rewards investment. Productivity profit should be the source from which all value-sharing occurs. When it is, variable pay plans become “self-financing”—benefits are only paid out of a superior value that has been created. When that happens, pay is generating a positive return to the company. Shareholders and CEOs should be happy to write checks for short and long-term value-sharing plans when they know their productivity profit is increasing.
4. Not operating a Total Compensation Structure. Most organizations make decisions about individual pay and benefit programs in silos. For example, they might construct a new bonus plan before they have established clear salary bands. Or they will design a phantom stock plan and make decisions about how many units will be available without measuring what their total value-sharing commitment is (bonus plus long-term incentive plan) and how much weight each variable plan should be given. What CEOs should insist upon is a Total Compensation Structure (TCS) that allows them and others responsible for the employee value proposition) to see the value of all compensation and benefit programs in one place by tier or other employee grouping. Then, when any decision about pay is considered, two things can always be checked—the TCS and the pay philosophy. The TCS gives the business leader a comprehensive picture of the organization’s rewards commitment to employees and allows him or her to evaluate each program as they would an “asset class” within an investment portfolio—which is really what it is. The pay philosophy, in turn, reminds the CEO what the overall pay strategy should help the company achieve and, as a result, what components it should include.
5. Not measuring line of sight. CEOs should approach compensation planning strategically—as they do other endeavors within the organization. As it relates to pay, this means they ensure that the enterprise’s compensation approach helps create alignment between the company vision, its business model and strategy, employee roles and expectations, and how people are rewarded for fulfilling those expectations. That’s called line of sight and it needs to be monitored and measured—even if only informally. Without line of sight, chief executives run the risk of their employees experiencing a disconnect between the priorities that are communicated in planning and strategy sessions and those their pay conveys. If an employee hears the CEO talk about the importance of doubling revenue over the next three years, but everything within his pay construct is tied to short-term performance, he is being pulled in a strategic direction by his compensation plan that is at odds with the focus leadership wants.
Each of the mistakes CEOs make regarding pay is easily corrected. It just requires them to engage in a bit more comprehensive planning than most devote to compensation issues. The payoff for spending the time to “do it right” is a value proposition that drives the performance needed for the company’s growth goals to be realized.
To learn more about how to develop a more effective rewards approach, attend our upcoming webinar entitled—Guaranteed vs. Incentive Pay: What’s the Right Balance.