Designing Incentive Based Executive Compensation Plans

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    Executive compensation plans can be fraught. When such plans are revealed through media, they often are met with knee-jerk disapproval from a public that doesn’t get that such pay results from efforts to best the competition to lure the top talent, who will help create growth, which is good for society, right? Likewise, incentive-based plans are beneficial to stakeholders since they help motivate employees to meet performance goals.

    Still, there is a public relations problem when it comes to such plans, mostly owing to reports over the years of ones that were at odds with the interest of private shareholders, or that abused public funds. Therefore, it can be a challenge to design incentive-based compensation plans that both align with organizational goals and pass public muster. But it can be done. Here’s how.

    Getting Help for HR

    These days, there is a growing number of compensation and benefits specialists within human resources management. And rightly so, since with today’s economy and work environment, companies need to focus on this area to sustain their competitive edge. While HR professionals apprise management of the factors involved in implementing or reworking an exec compensation plan, nearly every organization requires some external assistance with design and management.

    The Communications Process

    Oftentimes, an executive compensation plan flops because of a breakdown in the communications process. Perhaps no employee feedback was sought in plans to incentivize exec performance, for example. Or maybe goals weren’t clearly defined or stated, or job descriptions weren’t reflective of execution compensation plan goals. In all, make sure you have in place a clearly communicated pay philosophy well before any changes are made. 

    Prioritize Metrics

    Metrics are crucial to bolstering a company’s performance. After all, designing executive compensation plans is time-consuming so you want a good return on that investment, which means signing on with a consultant.

    It’s also a smart idea to establish a pre-changes baseline then gauge results using the same methodology at the conclusion of a certain period.

    Use Technology

    Automation has enabled the swift generation and analyzation of compensation reports. That’s in contrast to the old methods of manually sorting through a myriad of files to locate and compile data. There’s technology available that can assess, track, and pay bonuses and commissions, and collate data from disparate systems to give management a broad view of pay versus performance. Make good use of it.

    Plan Design Requirements

    When crafting a sound compensation plan, you must balance shareholder needs, recruitment and retention, performance-based pay, and the measurement of cost as measured against perceived value.

    There are some guiding trends in exec compensation, including:

    — More of such pay is tied to performance, hinged upon such measures as profits and cash flow.

    — Incentives are more tied to long-term results. Increasingly, incentives such as stock options comprise most of total direct pay.

    — Organizations have slashed exec perks, although this may change as companies adjust to disruptions caused by the pandemic. Employees are calling more of the shots.

    Total Compensation

    There are various accounting, tax, and regulatory considerations that comprise every element of an executive compensation plan, so you must devise a strategy for how each element will be used. All elements of the executive compensation plan must be addressed in the total compensation strategy.

    As you can see, designing incentive-based compensation plan includes basic design elements plus practical issues and compliance with federal laws. Your best bet is to enlist the assistance of an HR consultant such as Mercer, which can bring all these elements together for you. And you’d better move fast, since things continue to evolve, and flexibility is key.

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