Compensation Force

Best of the Force: Ask Yourself... What Job Did You Hire That Pay Plan to Do?

Designing new compensation plans.  Many of us are in the final throes of this activity as we roll into the last month of the year. 

Perhaps a paradigm shift could deliver that final kick of energy we need to put the final touches on a plan that will deliver results. Perhaps it would help us to step out of our HR heads for a few moments and take a page from the playbook of Harvard Business School professor Clayton Christensen, author of The The Innovator's Dilemma and How Will You Measure Your Life?, and regarded as one of the world's foremost authorities on disruptive innovation.

Christensen advocates approaching product design and planning with what he describes as a "job-to-be-done" point of view.  As he says:

The jobs-to-be-done point of view causes you to crawl into the skin of your customer and go with her as she goes about her day, always asking the question as she does something: Why did she do it that way?

To illustrate this approach, Christensen shares the story (in his MBA course) of a fast food restaurant that wanted to improve its milkshake sales.  The company tried looking at the challenge using the demographic segmentation approach favored by marketers (who is the typical milkshake drinker?  what do they like in their milkshake?), but had no luck in improving sales.  The company then engaged one of Christensen's colleagues, who approached the situation by trying to learn what "job" the customers were "hiring" the milkshake to do.  He describes the experience in the interesting - and entertaining - video below.

At the center of this experience is a fascinating mind shift, a way to frame design problems in a whole new light.  Perhaps we could benefit from such a shift in perspective as we go about our business, assessing how well our pay programs work and attempting to make them better.

Looking at it from the perspective of one of our most basic "products", the base salary structure, we could ask our key customer, the line manager:

• For what job does the typical manager "hire" the salary structure - what are the circumstances under which they consult it and what are they hoping to achieve?
• When does it do the job well, and when does it not rise to the occasion?
• When do they have to "hire" other tools to get the job they are trying to do done?  What other tools do they turn to and what sort of help do these tools provide?  Or are they forced to "jerry-rig" the structure in order to get the job done?

And yes, we may need to dig and push around a bit (or to use Christensen's words, crawl under the skin) to get to the true job the manager needs to get done, as many of them are attempting to hire that structure to simply help them circumvent salary policy and budgets in order to simply maximize the money they can give subordinates.  Perhaps this can tee up an opportunity for mutual exploration, education and understanding.

At any rate, I find Christensen's framework an interesting one with which to engage our customers in attacking some of our thornier design problems.  What about you?

Long-Term Incentive Insights

What's driving the use of long-term incentives.  A recent on-point survey from Pearl Meyer & Partners provides a few insights gathered from over 200 participants, ranging from Fortune 500 members to not-for-profits and emerging high-growth companies, and including both employee and outside director perspectives.  (Of the 205 participants, 60% responded as employee managers of their respective organizatins and 40% as outside directors of their companies.)

Some select outtakes from the survey's findings:

Above market LTI targeting is common.  When it comes to benchmarking LTI, 38% of respondents target around the 50th percentile while another 41% target above the 50th percentile.

Outside directors and employee managers have some different viewpoints on LTI objectives.  While both outside director and employee respondents cite incentive and retention as their top two objectives, their points of view diverge when considering market competitiveness and wealth accumulation as goals.  Employee managers overwhelmingly cite market competitiveness (78% of employees versus 48% of outside directors) and wealth accumulation (25% of employees versus 9% of outside directors) as LTI objectives.

Hesitation about using LTIs as special retention awards.  Both employee managers and outside directors agree that these "sometimes" make sense.  The strongest opposition to special awards comes relative to using them in response to a market downturn (22% of respondents say "never or rarely", 66% say "sometimes") or when the firm is acquiring (29% say "never or rarely", 53% say "sometimes") or divesting (23% say "never or rarely", 58% say "sometimes") another unit.

TSR (total shareholder return) not the top performance consideration.  73% of outside directors and 58% of employee managers say they always consider company performance in making LTI awards.  However, 53% of respondents say they never or only sometimes consider TSR.  61% of respondents say they consider performance other than TSR always or most of the time.

Most new hire LTI awards not tied to specific targets or guidelines.  More than half of the respondents don't rely on specific targets or guidelines when determining new hire awards.  The two primary factors most cited in new hire award size are equity of peers at the firm and typical annual award size.

More information on the study can be found here.

Creative Commons image "Money" by Aaron Patterson

Rewards Make Strategy Perform Better

I like to argue that we should be holding our compensation programs - and the money they represent - to a higher standard.  Research examining how well company strategy delivers on its potential - and where and why it fails - sheds some light on the important contributions that rewards can make.

Your reward programs, in reality, do a lot of things beyond delivering economic and psychic value to employees.  Any of you who've bumped into the unintended repercussions of a misguided incentive plan know this to be true.  Reward programs also:

1. Focus: Call out top priorities
2. Guide: Guide employees to areas where their effort can create the most value
3. Create consequences: Create consequences, financial & non-financial, for success & failure
4. Weaken silos: Encourage teamwork & collaboration
5. Improve measurement: Bring attention & pressure to measurement and measures
6. Drive development: Drive and reward the development of skills and capabilities

Can these things measurably improve how our organizations execute strategy?

Research (covering nearly 200 companies worldwide) conducted by Marakon Associates and reported by Michael Mankins and Richard Steele in their Harvard Business Review article Turning Great Strategy into Great Performance found that the average company's strategy delivers only 63% of its potential financial performance, the financial projections set forth in the company's strategic plan.  Clearly, a significant strategy-to-performance gap exists.  What causes it?

Mankins and Steele take a look at the flip side of that 63% average realized performance to see where the other 37% of performance gets lost.  In their study, managers at the participating companies reported the specific places where strategic planning and execution breaks down.  Take a look at the chart below to see what they discovered (or click on it for a larger image).

So, here's my point.  Well over half the factors that cause strategy execution to fail are things that rewards can impact.  Specifically:

 
My math and Mankins' and Steele's findings suggested that our concerted efforts to align reward pland and practices with business strategy have the potential to reduce the strategy-to-performance gap from 37% to as low as 13%.

Of course. It is unlikely that rewards alone can completely eliminate each of these roadblocks.  But there is a strong case to be made that rewards - done well - can influence each and every one of them; in some cases to a strong degree.

So let's get to work making it happen!

LTI's Gaining Serious Traction at Private Companies

New research on the pay practices of privately held companies conducted by WorldatWork and Vivient Consulting shows that a majority of these organizations now offer long term incentives.  The survey, previously conducted in 2007, reflects the practices of 232 private U.S. companies with revenues ranging from $100 million to more than $5 billion.

Study findings show that long term incentive prevalence at private companies - despite the challenges these organizations face in terms of valuation, liquidity and ownership considerations - has increased from 35% in 2007 to 61% in 2011.

The types of long term incentive plans most widely used among participating companies include:

• Performance awards or long term cash plans - 52%
• Phantom stock and stock appreciation rights (SARs) - 33%
• Stock options - 26%
• Restricted stock - 19%

The study also notes that the use of short term incentive plans among private companies has increased since 2007, from 79% to 95%.

On Simple-Minded Pay Interventions in Complex Organizations

I confess to being fascinated by the parallels between the behavior of organisms and the behavior of organizations.  Have been ever since I read Meg Wheatley's Leadership and the New Science more than a decade ago, a book that forever changed the way I look at the world.

And so I was drawn to the analogy I found in an article on (of all things!) drug development in this past weekend's Wall Street Journal, Drugs That Are as Smart as Our Diseases,  where author Matt Ridley explores the bind faced by the pharmaceutical industry today.  In a nutshell, the industry is struggling enormously to develop productive drugs in an environment where natural selection is producing increasingly resistant disease strains and blockbuster drugs are losing their patent protection at an accelerating rate.

The problem, as Ridley states it:

Human biochemistry is supremely intricate and robust.  It resists cures that rely on deploying simple, targeted molecules.

What does this have to do with HR and compensation?  Well... I would submit that the dynamics of human performance in organizations are also supremely intricate and robust, yet we are forever prone to seek the quick, isolated solution - like, say, the lone incentive plan - to fix our performance challenges.

As Malcolm Young, CEO of the drug discovery firm e-Therapeutics so succinctly puts it: "There is no single soldier that we can shoot whose demise would significantly affect the performance of the army."  Can't the same really be said for single-minded talent interventions? Just as biochemical networks are designed to work around the loss of any one node or molecule, so our organizations have proven themselves uncannily capable of finding the workarounds for our simplistic pay interventions - throwing back in our faces those things we are fond of calling "unintended consequences."

There's a lot that we, as HR and compensation pros, can learn from science and the study of live organisms.  Can we absorb and apply these lessons?

Image courtesy of en.wikipedia.org

Compensating Partners in a Start-Up

A few years ago, I provided a link to a post on partner compensation in a start-up that David Maister (author of the seminal book on consulting, The Trusted Advisor) had on his now-retired blog.  While never claiming to be a compensation expert or someone in the business of advising start-ups, David shared some wonderful points and principles around structuring partner rewards in emerging organizations - a challenging area to navigate without a lot of best principles or practices.  I've sent links to this post out many times.  It occurred to me, after sending it out for the second time this week, that it might be worth featuring here again for the benefit of those who might have trouble finding it otherwise.

A reader wrote in to ask David: What's the best way to structure a compensation system for partners in a small startup firm? ...Should it be simply a division of retained earnings by ownership share? A formula that builds in factors such as total sales, revenue managed, etc? Obviously, fairness and trust among the partners is critical.

Here, in their entirety (something I don't normally do), are the thoughts that David shares:

(i) I always like "look ahead" systems, not "look back" systems. In other words, let's discuss how we are going to allocate next year's profits. Once we've agreed on that, and each have our shares, we can move together during the year aligned in our interests, focusing on making the whole enterprise successful. If that proves to be a little unbalanced, then we'll tackle it at year end when we plan the division for the year after that. However, if we have a system whereby you're always looking back - trying to allocate funds based on performance that has already taken place - you'll always be fighting over differing interpretations of history.

(ii) Stay away from formulas based on origination or anything else. In a start-up there are just too many things that need to get done to allocate incomes on a few measures.

(iii) Recognize that, even in a tiny partnership, it's possible to invent a system that has different categories of splitting available cash. For example, you could begin by saying "tranche" number one of any end-of-year cash is to be split by ownership shares, while tranche number two is to be split on some other "performance" basis. The weighting between these two might vary over time. Initially, to encourage a focus on overall success, you could say "Let's allocate 80% to reward for ownership" which gets everyone focusing on the firmwide result & allocating only, say, 20% to be divided to the basis of performance. As the years go by and you add more people, you will then have choice as to the weighting between the reward for ownership and the reward for performance.

(iv) In general, I like systems where everybody shares in the overall performance (relatively fixed shares, adjusted only infrequently), but that can only be sustained if your "system" is good at addressing performance issues, so that you tackle performance problems by talking to each other during the year, not trying to invent crazy formulae. So, how well can you and your partners talk with each other? Are you the type of people who are comfortable addressing issues during the year and commenting if you think the burdens are not being equally shared? If so, you won't need the comp system to do it for you.

(v) What you REALLY have to ask yourself is: do I want to be partners with this person? With these people? Am I prepared to trust that we can work it out? IF yes, then any scheme will get you through the first couple of years, and you can re-examine it later. If the answer is no, then no comp scheme will cover up that lack of trust.

A number of people added their comments and thoughts to David's.  Here's what I said...

I strongly second your preference for "look ahead" rather than "look back" systems (i). Then everyone involved is free to move forward and act based on a shared understanding of the "rules", rather than being forced to negotiate them after the fact.

I also appreciate your thoughts on establishing an agreed-upon approach to allocating available cash (different "tranches"), and distinguishing between what earns based on ownership and what one earns based on contribution or performance. The tricky thing, at least in my experience, is defining and getting agreement on what is meant by performance and how it is measured. In response to your comment in (ii) about using "origination" to allocate income, I find that it is difficult to avoid business development (what I believe you mean by origination) as part of the income equation. The business owners I have worked with in these circumstances typically feel very strongly about motivating and rewarding the hard work of business development as a critical component of their initial compensation approach.

Finally, I echo your sentiments about ensuring that a good share of the income allocation or compensation approach focuses on collective performance, to reinforce the spirit of shared destiny that is so important in the early days of an organization.

Thanks again for a helpful and thought provoking post!

Got your own wisdom, advice or information on compensating partners in a start-up?  Please share it with us here!

Image courtesy of simplebusinessadvice.org

Is There a Place for Ambiguity in Rewards?

Here's a question for you.

In a recent Board level conversation, I found myself part of a debate about the need for clarity in executive rewards. On the one hand, I had a chief executive expressing a preference for a more structured and clearly communicated compensation package.  On the other hand, I had a Board Chair articulating the belief that it is an executive's role to manage ambiguity and that the compensation package ought to reflect this fact. The details underlying the debate aren't important here - but I think the question at its core is an intriguing one.

I've run into plenty of hazy compensation plans before (I'll bet many of you have, too), but typically the haze is there courtesy of an unclear strategy, lack of commitment to or certainty around measurement, or just an unwillingness to tackle the full task of plan definition and communication.  Not this time.  This was the first time I encountered plan ambiguity coming from a place of strongly held principle.

I get that we live in an increasingly uncertain world and that dealing with uncertainty effectively is part of the job for most of us.  And a key challenge and expectation for those in an executive role.

But I also believe (and I think that this is a deeply held principle for me) in making compensation plans - for any employee and particularly for executives - as clear and unambiguous as circumstances permit.  Where is the value in leaving them guessing - unnecessarily - as to our meaning or intent?

What about you - got a strong opinion one way or the other? Does ambiguity have an important and purposeful place in compensation plans?  For executives?  For anybody?

Where's MY Pay Czar? Why We Need a Total Rewards Audit of Congress

With Congress (mostly) in recess and the rest of us getting a chance to catch a breath before our elected representatives return to make any additional, er, progress, I'd like to take this moment to make the case for a total rewards audit of Congress.

The purpose of a total rewards audit, as you know, is to examine the full scope of rewards (financial and non-financial) in light of the key accountabilities and expected performance results of the role as well as the employer's (in this case, the U.S. taxpayers') broad requirements and objectives, to ensure that there is alignment. 

In this audit and in the spirit of "total rewards" as we've come to understand it, it will be important to consider all elements of Congressional rewards; not simply salaries and benefits, but the full spectrum of what is provided and made available in exchange for service in the House or Senate.  This should include, but not be limited to:

• Perquisites
• Power and influence
• Recognition, attention and acknowledgement
• Continued and future employment/service opportunities

Conducting the audit will demand that we develop a deep understanding of the full motivational context of the role of the Congressional representative.  This will require asking and getting responses to questions such as:

• What attracts people to service in Congress?
• What causes them to seek re-election and additional terms?
• What motivates them to seek leadership roles in Congress?
• What causes them to end their service, to pass up the opportunity to seek additional terms?

And then, finally, it will be critical to take what we learn in the information gathering steps above and determine:

• What behaviors and outcomes are being driven by the total reward package, overall as well as the various individual elements?
• Are the behaviors and outcomes being driven in alignment with the role's key accountabilities and expected performance results?
• Are the behaviors and outcomes that are being driven in alignment with the long term requirements and objectives of the "employer"?
• Are there misalignments that might be creating the motivation to work and act in ways that are at odds with key accountabilities, expected performance results and/or the requirements and objectives of the employer?
• Are there misalignments that create the motivation to push short term results over long term value and viability?  To take risks on behalf of the employer that are out of proportion to the possible benefits?
• What changes to the total reward package, and/or its individual aspects and elements, should be made to strengthen overall alignment and to correct the misalignments, if any, that are discovered?

It's probably just me, but I can't help thinking that such an audit might produce some enlightening and actionable findings.  As a member of the collective body of citizens that comprise the employer in this scenario, I think it's high time someone took a closer look.

I mean... where's my Say on Pay and Disclosure of Risk? Where's my Clawback Policy?

Where's MY Pay Czar?

Image: Creative Commons Photo "U.S. Capital" by Cliff1066

Avoiding Executive Compensation Calamity: Case Studies & a Tool

Awhile back, WorldatWork created an Executive Rewards Questionary, a dictionary of more than 200 questions designed to help any interested party - be they Board member, HR practitioner, investor or journalist - think through the complex choices and implications involved in executive compensation design.  Questionary questions have been organized into four main categories: Internal Environment, Stakeholders, External Environment and Disclosure and Transparency.

Recently, a graduate student (Diane Vavrasek), funded by a grant from WorldatWork, took on the project of applying some of these questions retrospectively to some of the highest profile executive compensation debacles of recent times, from Enron and WorldCom to the Home Depot and the New York Stock Exchange.  The result, Case Studies in Optimizing Executive Compensation Design, is an interesting look back at the questions we all wish someone had raised early one in these high profile and ultimately embarrassing situations.

An excerpt from one of the case studies, this one on Fannie Mae:

In late 2004, both the CEO and CFO stepped down after the company restated earnings by roughly $10 billion due to accounting irregularities. The departures were publicly referred to as “retirements.” The CEO and CFO received the same severance and retirement packages they would have had they left with unflawed performance records.

The executive compensation program approved by the board included a special option program that granted options to executives that immediately vested once an earnings-per-share goal was met.
The board also gave the freedom to executives to sell vested options and shares at any time, allowing the CFO to collect on the sale of his shares despite the restatement of earnings.

Internal Environment
How does expected performance relate to the current business outlook?
What are the results that need to be achieved in the short and long term?
Is the legal department comfortable with this design in the current legal/regulatory environment?

External Environment
Will this information become public knowledge?

Stakeholders
What are shareholder expectations about your compensation programs, and how do they affect plan design?

The Questionary and the Case Studies are available to anyone in the community at large.  Enjoy!

Image: Creative Commons Photo "Question Mark" by Margaret Anne Clarke

How to Fix Executive Pay: A Harvard Business Review Debate

In response to the all the attention on executive pay these days, and with corporate leaders attempting to outrun federal regulators in addressing concerns and issues about how executives are rewarded, Harvard Business Review has createda debate forum on how to fix executive pay.

Is it fair – or useful – to limit executive compensation?

Do limits hurt companies’ competitiveness?

Is CEO pay a moral issue?

What’s the best way to structure executive pay?

HBR has invited a group of experts to lead an online discussion of these and other questions. 

Recent posts include:

How to Help Directors Increase Oversight of Pay by Don Delves, the Delves Group (July 1)

To Fix CEO Pay, Focus on the Big Shareholders by John Mackey, Chairman & CEO of Whole Foods Market (June 30)

On Executive Pay, Simpler is Better by John T. Landry, Business Development Editor at Harvard Business Review (June 25)

How to Tie Equity Pay to Long-Term Performance by Lucian Bebchuk & Jesse Fried, Professors of Law at Harvard and U.C. Berkeley Law Schools, respectively (June 24)

Executive Pay, It's About "How", Not "How Much" by V. G. Narayanan, Professor of Business Administration at Harvard Business School (June 22)

And there's more...

Tune in for an interesting and informative debate on this critical topic from a diverse group of business leaders, academics, researchers and consultants.