A well-designed executive compensation plan focuses on a number of important objectives. It attracts and retains the talent necessary to lead complex organizations to success. It aligns the interests of executives with those of shareholders. It focuses the efforts of executives on achieving the organization’s business goals, both short- and long-term. Finally, it provides programs that are regarded as credible and responsible by investors and other stakeholders, and that meet legal and regulatory requirements. While these objectives have not changed, the manner in which companies are achieving these objectives is evolving rapidly. This is unfolding in a context of growing demands for transparency and accountability. An organization developing an executive compensation program will improve its chances of success by following five approaches:
- First, define the organization’s short- and long-term strategies, objectives and key
- Second, vest responsibility for executive compensation in a compensation committee consisting of independent board members.
- Third, take a total rewards perspective by looking at each component of the compensation program as part of a portfolio of provisions rather than stand-alone items
- Fourth, establish the executive compensation portfolio to provide an appropriate allocation of base and variable (at risk) compensation, short- and long-term programs and performance incentives versus retention and attraction incentives. The optimal mix will vary by company.
- Fifth, make the program as simple as possible
Objectives and Measurements of Executive Compensation
All executive compensation programs and decisions should derive from the performance objectives and measurements of the participating executives. Traditionally, executives’ performance measurements have been focused on hard financial metrics such as earnings-per-share, total shareholder returns, revenue and profit before tax.
In recent years, there has been an increasing concern that an excessive focus on financial results will actually cause a decline, over time, in financial performance. The argument is that financial results are the result of doing everything else well. Executives should also be measured on that.
Executive performance has normally been measured against the organization’s pre-established targets. An emerging practice is to measure company performance, and reward executives based on the organization’s performance relative to that of a designated group of similar companies (usually in the same industry). Since publicly available performance data from other companies is almost all financial in nature, so are comparative performance metrics.