CEO's: Are you - and your Executive Compensation Plan - ready for your new fiscal year? (White Paper)
A critical question for CEO’s and boards of mid-small cap companies – or anyone helping the CEO create and strengthen your firm’s executive compensation strategy.
Jack Byrne, Principal
When is your fiscal year set to begin, and are you and your executive compensation plan solidly prepared? Executive compensation strategy and plans are a key CEO responsibility for driving performance success and assuring long-term growth. Executive compensation plans also help assure the ability to attract and retain key talent. The demands on comp plan effectiveness have certainly multiplied in this era of continually rising performance expectations and intense public scrutiny of executive compensation levels. While thinking about sitting down for this year’s performance reviews, or what changes are needed for next year’s plan, CEO’s face critical decisions on compensation structure. It’s more than just asking “what objectives do we target?”
Your annual timetable isn’t complete unless it includes – even if privately – reviewing and updating your executive compensation plan strategy and structure. Skip or shortchange this important annual review, and you put both you and your firm’s performance at risk. But let’s face it, just your reporting and planning-budgeting process alone can be all-consuming. Our mission at Ascend Consulting is to help companies map the structure for success with executive compensation, and this article highlights the critical questions targeting the most frequent key deficiencies.
I. THIS YEAR: Let’s begin with your upcoming performance reviews:
As you look ahead to sitting down with each of your key executives for that all-important review, we recommend looking beyond just your evaluation format and methodology and begin by asking...
Will you have solid confidence that your company plan and total target compensation is market competitive? How long has it been since you had a reliable independent competitive analysis – or do you just hope to get by for another year? It’s a common belief that not everyone likes these performance review discussions and they certainly get put off in many firms. But look beyond just your format, methodology or goal setting process for answers. We believe that some of the anxiety is actually rooted in a CEO’s lack of trust in the overall compensation package valuation. This can arise from a false sense of the market, or comparison data that is out of date or isn’t relative to your company situation. It’s also problematic when the different compensation elements are not sized appropriately (salary plus all forms of short & long term incentive, perquisites). However, when you confirm that your plan is market competitive, the boost in your confidence will markedly improve your review discussions.
How do you obtain a reliable competitive confirmation? Most mid-small market companies don’t have staff who are experienced in evaluating or designing executive compensation. You may find studies available at several price levels, but the data may not closely match your industry segment, size, location or other key factors. Many general HR support firms are great for general company compensation, but may not have the specialized knowledge or experience to handle CEO and executive positions. Or if an outside firm is already doing work for your company, they may have a conflict of interest in also advising on executive pay. Our recommendation? – Find a reputable independent firm that specializes in executive compensation. They can readily perform a skilled defensible competitive analysis for all components of your exec compensation package, and the additional key issues covered in this article. The right firm is experienced at solving and incorporating your biggest executive needs.
Unless something major changes for your company or the market, this competitive evaluation may need only a small update each subsequent year. Take this important step, and be ready to sit down with more confidence in your next review conversations.
II. NEXT: What about the coming years’ total compensation plan?
It’s too late to change the plan for the current year, but the future is in your hands. In the big crunch of setting financial plans and prioritizing specific objectives (usually annually), some companies mistakenly miss even a basic annual checkup of the total executive compensation strategy and plan. Some companies that replaced annual planning with a continual rolling process may find themselves surprised by changes that crept in slowly. These unfortunate firms find their mistake too late when performance isn’t ideally motivated, strong teamwork is absent, they lose key executive talent or are unable to adequately hire for senior strategic positions.
To face this need amidst the crush of other priorities, we present here a basic annual checkup that helps a mid-small cap firm quickly measure the need for major structural adjustments in their compensation plan. Just like your own medical health, you hopefully won’t need extensive surgery or redesign every year, but this checkup will help you signal when it’s time.
ANNUAL CHECKUP: There are eight critical up-front target areas for a basic annual Compensation Plan “checkup”…
1. BUY-IN: It’s critical to verify that the executive team has total buy-in and full understanding on the exec comp plan. But how? One common “real world” test for us at Ascend is to ask and listen as executives explain…
- How they are doing on their comp plan?
- How the plan is connected to their performance?
- How do comp plan provisions surface in their periodic financial or operating reviews and decision making?
We want to hear clear basic, connected and living linkages. It’s a clear danger sign when the plan is sufficiently outdated to be invalid, or the incentive results are a separate if not frequent topic among the senior team, or the executives can’t readily explain the plan without referring to the document.
2. TEAM: Does the Compensation Plan – especially the incentive portions - bring the executive team together for higher performance by effectively driving real team collaboration? A good foundation for trust is created when executives know that the plan has been market-competitive tested. We usually recommend resisting the temptation to build elaborate differentiated performance measures at the executive level, based on our own experience and reliable studies. Small individual metrics may be fine, but “One for all and all for one” metrics are powerful binding agents.
3. ALIGNED & CONNECTED: A full discussion of goal setting for annual incentives alone is beyond this article’s scope, but we will discuss checking major elements. As CEO, be especially aware of the connections between your financial and “annual” planning process and the Compensation Plan. Keep track of key decisions and assumptions that you build into your strategies and financial-operating plans. Let those points focus key provisions in the Compensation Plan, and/or flag areas that need internal or outside exploration. Work to keep it simple – focus on the key-critical few to point the way.
4. CHANGED SITUATIONS: In an annual checkup, it’s important to recognize any changes that signal the need for potential comp plan adjustments. These can include major changes in ownership, strategy, company reorganization, market, customers, key risks, regulations, past or future hiring-replacements, talent availability, competition, geography, and economic conditions. If any of these are real or on the horizon, that’s a signal for potential adjustment.
5. TAX & REGS: Any changes in tax or regulatory changes impacting compensation or your comp plan?
6. PERFORMANCE: How is the company performing? Missing performance goals isn’t a guarantee that the compensation plan needs to change. But missed performance indicates the need for some form of company change, and repeated misses require changes with definite comp plan impact.
7. COMPENSATION TRENDS: Have you been briefed on key current & emerging compensation trends, or special approaches for your industry or market?
8. INDEPENDENT: The evaluation & decision process, and data, are based on independent sources to avoid any conflict of interest. Deciding Board members are independent directors.
Make sure that these six are addressed annually. If you recognize large concerns, seek help to sort through expert causal analysis and quickly identify best solutions.
III. A DEEPER CHECKLIST
What if you want to check deeper - what else can be important? Here’s a checklist highlighting further insights and additional key factors than can also be used annually – or whenever the train is off the tracks.
Does your company’s future Executive Compensation Plan…
- Align with your Total Compensation Strategy? Do you have a clear stated compensation strategy, or does it need an update?
- Strategic Direction: Focus on key strategic directions that you are starting, continuing or changing?
- Elements: Assemble the right mix and degree of total compensation elements? There are far too many possible elements in an effective total compensation plan to cover in this article, and each has a key role to play for different purposes. Selecting and sizing the most important elements for your firm’s future will have a profound impact on your success and growth.
- Balanced Timing: Strike the right balance between annual and long term incentives that will focus your team effectively on both short term performance and long term value creation?
- Risk: Encourage prudent risk taking required for growth, without over-incentivizing unreasonable risks.
- Integrity: Maintain appropriate safeguards to ensure that players “win the game” with integrity while creating valid results? (especially appropriate after 2016 Wells Fargo revelations)
- Company changes: Keep up with changes in your firm’s revenue, mission, markets, organization, geography-locations, stakeholders, balance sheet, products and services, and other factors?
- Market Changes: Evolve with or lead changes in the market, customers and key trends in this fast-paced world – including how competitors go to market, products, technology, speed, your competitive situation, and economic conditions?
- Regulations: Keep pace with – and take full advantage of - any IRS or regulatory requirements? Many elements are impacted every year by new or revised IRS or other rulings. So awareness, caution and expert advice are necessary.
- Comp Trends: Have you been briefed on key recent compensation trends?
This checkup and additional checklist is a great way to begin an annual assessment of your total compensation strategy and plan. It helps to target areas that need special attention, and can be modified for your particular situation and goals.
Before you implement, take a last look to be sure that your exec comp plan focuses on the key few and will robustly perform over your time horizon – whether that be one year for the annual portions or 3-plus years for the long term incentives. Then work with your team to activate towards success.
You may not have a lot of time to get elements aligned and documented, so get this assessment and the resultant moves plugged into your annual plan timetable. The CEO and her/his team’s time is also valuable, so look for ways to get help in meeting the time crunch. An executive compensation consultant can not only help with this workload, but save you time through their expertise, market competitive knowledge and greater familiarity with different options.
Since 1999, Ascend Consulting has delivered independent competitive intelligence, seasoned guidance and powerful solutions for executive and board compensation. Their clients are successful CEO’s and boards, who benefit from Ascend’s unmatched combination of expertise, C-level insight and unique mid-small cap modelling. Jack Byrne joined with his partner David Lough as principal of Ascend after 20+ years of CEO/COO experience leading successful Northwest companies. You can reach Jack at email@example.com or the website www.ascendnw.com.
Note: This checklist is suitable for mid-small cap firms. Some companies have more extensive needs. Subchapter S corporations may have additional requirements (e.g. IRS findings on insufficient compensation). For public companies, the last eight years have brought extensive new SEC or IRS requirements beyond the above discussion and prior basic disclosure rules (e.g. CEO Pay Ratio, Say on Pay, Say on Golden Parachute, Pay for Performance). These are also important if you may go public or might be acquired by a public entity. Not for profits face critical IRS rulings on compensation for top executives & the board. These issues are outside the scope of this article on private mid-small cap firms. For these or other more extensive requirements, be sure to address your risks & concerns with appropriate legal and accounting advisors as well as a suitable compensation specialist.
Ascend Consulting Seattle, WA firstname.lastname@example.org 206-849-3110