What Informed Shareholders Want Compensation Committees To Do

When managed as part of an overall high performance work system that in
turn is part of an overall business system, performance-based executive compensation can serve as a strategic asset and sustainable competitive advantage.
That’s the goal.
(Mark W. Sickles, 2009)

Imagine your CEO kicking off a new business year saying to all exempt employees, “You all have the same elements of compensation as me, and your elements of compensation are linked to the same objectives as mine. This reflects the fact that we all have the same job: Assuring long-term shareholder value.” This is a combination of what two great CEOs – Rob Cawthorn and Fred Poses – said to their workforces to inspire and motivate them to achieve extraordinary results.

These two CEOs understood the most important thing to know about executive compensation: Program changes are well-planned if - and only if - they improve the performance of the whole firm in ways that increase long-term shareholder value. Meeting this standard of well-planned change is a key responsibility of the Compensation Committee, calling for the ability to manage executive compensation as an integral part of a larger whole. Far from easy; requires an imaginative effort; “job one” nonetheless.

Think of compensation as the engine of a race car. Base salary is the metal block, annual incentive the gas, long-term incentive the oil. All three are necessary but not sufficient. The power of the engine cannot be utilized until it is aligned, linked and working interdependently with the other parts of the whole.

Once you view compensation this way – as the engine that powers your organization - you begin to see that the most important of the “Big Three” questions of executive compensation is, “What for?”, followed by, “What kind?”, and then, last, “How much?”. When you don’t have this view of compensation, you could become preoccupied with the last question. Easy to do; requires no imagination; costly derailment. You’ll burn up cash, stock, and shareholder value while your organization goes nowhere fast because you failed to “drop the engine.” Dropping and connecting the engine is much more difficult than filling up on gas and adding oil, but it’s essential to the Compensation Committee being a strategic asset and source of sustainable competitive advantage to the firm and its shareholders.


When you ask these three question - in the right sequence - as members of the Compensation Committee, you need to make sure the answers you get from the officers reflect a masterful understanding of the “significant few” principles of executive compensation:

Risk/Reward
Level/Mix
Fixed/Variable
Short Term/Long-Term
Internal Equity/External Competitiveness
Incent/Reward

As an example:

Compensation Committee: What are we paying our executives for?
Officers: For providing our shareholders with a return on their investment in the current year greater than that being produced by alternative investments of comparable risk; for making moves in the current year to put the company in a position of sustainable competitive advantage in the future; for practicing our shared values in ways that build distinctive organizational and individual character; for behaving legally, ethically and morally.

Compensation Committee: What kinds of compensation are we paying our executives?
Officers: A mixture of fixed and variable. The fixed is low risk pay in the form of
base salary. People will receive a base salary only after they have demonstrated they possess the knowledge, skills and abilities to manage our systems, in our structure, and practice our shared values, all to achieve our operational and strategic goals. They get this fixed element of compensation upon being hired, and will continue to get it until they cease being a member of the firm. This approach demonstrates the linkage and interdependence between our compensation system and our recruitment & selection, training & development, and performance management systems. By managing these systems as an integrated whole, we get more for our money than the competition, and have fewer incidences of costly terminations and replacements. This interdependent linkage is far from easy, and therefore a competitive advantage benefiting our shareholders.

The rest of the compensation is variable, also known as “at risk” compensation. We believe that, because we manage executive compensation as a part of an overall high performance work system (HPWS) that enables us to have a highly skilled, highly organized, and highly motivated workforce, we can skew our compensation towards the variable elements, both short and long-term, to a greater degree than our competition, thereby reducing our fixed cost structure while remaining externally competitive, providing the firm with another competitive advantage . Further, because our compensation system is linked to a well-designed strategic and operational business planning system through our performance management system, you and the shareholders can be assured that our executives will only be paid above-average compensation if the financial performance and strategic gains are also above-average, and that we will be paid less than market rates if our performance as an organization lags the average performance for our industry sector. And because our system assures a workforce tailored to our needs and environment, we are able to push the executive compensation program deeper into the organization than our competition and get an exceptional return on that investment. Doing so improves internal equity and external competitiveness, increases alignment of interest and efforts, and inspires and motivates the workforce to freely and consistently put forth an extraordinary effort. These are all indicators of a high performance workplace.

Compensation Committee: How much should we pay our executives?
Officers: Philosophically, we never want to be paid more than the shareholders feel we are worth. You as the board would not have hired us unless we were of that character. More technically, our pay policy is to target base salary at the 50th percentile of our market, or 45th if you prefer, and then target total direct compensation – base, annual, and long-term incentives – at the 75th percentile. To maintain alignment, we will always set our strategic and operational goals to also be above-average in the industry, creating a high performance culture of “superior pay for superior performance.”

By managing compensation as part of an overall HPWS, we are one of the few companies providing shareholders with a full return on their investment in our pay. When pay is not effectively linked to the overall business system, it can only be used as a “back-end” reward. In this case, the shareholder is only getting “50 cents on the dollar”. But when effectively linked to the business system, as we have done under your direction, compensation can be used as a powerful incentive on the front-end and throughout the business year. Our workforce knows that superior performance means superior pay, and they can see the connection between their daily work and the business goals that define superior performance. As a result, they come to work ever day ready, willing and able to make an extraordinary effort. This high performance environment is rare, valuable, difficult to imitate, and therefore another source of competitive advantage.

Summary:Whenever boards ask questions, it creates work in the organization. When boards ask the right questions at the right time, they can be more effective leading with the question mark than the exclamation mark. You now have a Compensation Committee blueprint to do just that. In doing so, you will meet the standard for today’s corporate director: Functioning as a strategic asset and source of competitive advantage. Good luck.

Copyright 2009, Mark W. Sickles. All Rights Reserved.