5 keys to effective executive compensation
A properly crafted executive compensation plan not only ensures you attract and retain the talent your business requires, it also effectively links the incentives for your executive team to the strategy and priorities of the organization.
The research for our annual CEO & Senior Executive Compensation Report for Private Companies shows that companies that prioritize structuring and implementing comprehensive executive compensation plans have better revenue growth and profitability than companies that do not.
An executive compensation plan needs to be thoughtfully prepared to ensure both short and long-term goals are considered. These 6 keys below will help your company to properly implement effective executive compensation strategies.
1. Use Metrics as the Basis for Incentive Compensation
A common mistake for incentive-based compensation is promising incentives that are not tied to specific metrics. By having only discretionary bonuses or incentives, executives are unaware what precisely they need to focus on to be successful.
For each executive, the metrics that are well within their control and follow the SMART criteria (specific, measurable, attainable, relevant and time-bound) should be used as the basis for their incentives. This way, they are aware of what they must focus on and they can optimize their work to achieve those specific goals. Sometimes metrics like revenue and profit are applicable, but, more often, there are better key performance indicators (KPIs) that should be used.
2. Effectively Communicate to Ensure Understanding
Another common mistake companies make is when there is a belief that compensation plans are well understood by the executives, but really there is a huge communication gap. Make sure every executive is fully aware of all of the components related to their compensation package.
If an executive does not have a clear picture of their total ability to accumulate wealth in their current position, the likelihood of looking for opportunities with more clarity of the upside is increased. Uncertainty is almost always bad for business, and this is a case where uncertainty on the part of a core team member can have unforeseen deleterious effects on a business.
Progress on a compensation plan should be addressed at least annually, outlining both short-term and long-term incentives. An even better idea is for quarterly communication where the core metrics to which incentives are tied are discussed. This prevents any miscommunication prior to when the awards are issued.
3. Benchmark Compensation Levels
If you’re trying to attract top talent, your compensation needs to be competitive. Use benchmarking tools and publications to ensure you’re compensating your executives in the way you intend.
In our research, companies often believe they are paying near the top-end of the spectrum for each of their executives when, in reality, they are at or below the median compensation level for similar companies.
Make sure the benchmarks you use are meaningful and relevant to your company. Using multiple reference points to compare your company (for example, by revenue, industry, region, and revenue growth) will give you a much clearer idea of how competitive your compensation levels are.
4. Value Company Equity Regularly
In our research, more than half of the companies we surveyed do not have a clear idea of what the equity awarded to their executives is worth. By granting equity-linked compensation but not tying them to any real value, you’re simply adding uncertainty to the executive’s total compensation picture.
If you plan on issuing equity-linked incentives, your company’s equity value should be appraised or estimated at least annually. At regular intervals (quarterly, annually, etc.), each executive should be told the estimated current value of their equity-linked incentives, as well as the expected future value.
5. Include Both Short and Long-Term Incentives
Providing a truly competitive executive compensation package usually requires that your executive team has both short and long-term goals from which they benefit financially should they be met.
A blend of incentive compensation that provides executives with cash incentives in the short-term and longer-term incentives that tie an executive to the overall success of the company helps to ensure your executive team is engaged and feeling rewarded for their hard work regularly.
Implementing an effective executive compensation does not have to be onerous, but it requires time, planning and dedication for it to work properly. We created our CEO & Senior Executive Compensation Report for Private Companies to provide companies with both benchmarks and best practices for their executive team.