Best Practices Article - PEOPLE

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SIX STEPS TO AN EXECUTIVE COMPENSATION PLAN

By Joe Few, ERI Advisors, Tom Miller, VisionLink Advisory Group and Steve Prince, TGB Consulting

Benefits of Executive Compensation

Why invest the time, money and effort in creating a separate executive compensation plan for your senior managers?

One answer seems obvious -- to keep your key players from departing for greener and more financially lucrative pastures.

For starters, says Miller, CEO of the VisionLink Advisory Group (a TA Program company), a good executive comp plan will align the behavior of your senior managers with the strategic goals of the organization. In the pursuit of short - and long-term objectives, providing monetary incentives -- both current and deferred -- will go a long way toward eliciting the behavior you need to achieve those objectives.

According to Price, a Vistage member who runs the employee benefits and compensation firm TBG Consulting, executive compensation plans give back what laws and regulations take away as people move up the pay scale. For example, "bracket creep" plus caps on benefits and other regulations often mean that executives put less away for retirement, as a percentage of pay, than rank and file employees. In addition, Price considers executive compensation a vital cog in the wheel in family businesses, especially when it comes to compensating managers to do things they might not have to in a non-family environment.

"Suppose you have an executive on the management team who is not a family member," he theorizes. "He may be asked to mentor a family member, act as interim management between generations or serve as caretaker until management gets handed over to the next generation. This executive will never own stock in the company, yet the family needs him to act like an owner. That requires finding creative ways to reward the executive in a manner close to what he could earn in a non-family environment."

Few, a Vistage associate who serves as vice president of ERI Advisors, sees executive compensation as a key ingredient in management transition and exit strategies, especially for privately held firms. Specifically, he believes that well-designed executive compensation plans help to:

• Maximize business value
• Provide a transition strategy for ownership and management
• Enable shareholders to realize their equity.

"In order for shareholders to cash out, you must have a leadership team in place that will enable the company to move on to the next generation -- regardless of which exit strategy the owners/shareholders choose," he explains. "A sound executive comp plan can play a major role in getting the right team in place and enabling them to execute a successful transition strategy."

Six-Step Process

Executive compensation plans range from simple, cash-only incentives to sophisticated plans involving a multitude of performance targets, complex formulas for determining payout, and different types of cash and non-cash rewards. Regardless of the nature of your plan, our experts recommend a six-step process for design and implementation.

1. Conduct a current-state assessment. In order to lay a proper foundation for the plan design, says Miller, ask yourself the following questions:
   
   
   • What is our basic compensation philosophy? How do we believe in rewarding people for the company's success?
   • In terms of compensation, where are we as an organization? Where are we trying to go?
   • What have we learned from the past? What has worked and what hasn't?
   • What does our strategic plan suggest in terms of the most effective types of executive compensation?
   
   "Compensation can be viewed as a matrix, with fixed versus variable on one axis and short-term vs. long-term on the other," he explains. "A thorough assessment of where you stand on each axis and what type of compensations plans you currently offer (and why) will help you gain clarity around where you need to go."


2. Establish the plan goals and objectives. Step two also involves a series of questions, including:
   
   
   • What is the purpose(s) of this plan? What do we hope to accomplish?
   • Are we attempting to modify behavior or simply reward outstanding performance?
   • Do we want to focus on specific performance objectives? If so, which ones?
   
   In this step, suggests Miller, most (if not all) of the answers will come straight from your strategic/business plan.
   
   "An executive comp plan should communicate the kind of behavior that will produce the best financial results for your executive team and for the organization as a whole," he explains. "The best way to accomplish that is by aligning the plan with your short-and long-term strategic goals. That process of creating alignment will dictate most, if not all, of your plan goals and objectives."


3. Determine who participates. According to our experts, identifying plan participants depends on a combination of individual and organizational criteria, including:
   
   
   • Your compensation philosophy and organizational culture
   • The goals and objectives of the plan
   • Your company's financial resources
   • The individual's base pay
   • The individual's job responsibilities and potential impact on the company


4. Design the plan. This is by far the most complex piece of the puzzle. In addition to all the considerations involved in the first three steps, plan design must also take into account the following factors:
   
   
   • A wide variety of compensation tools and techniques
   • Monitoring, measurement and reporting issues
   • Tax, legal and accounting issues
   • ROI goals of the owner/shareholders
   • The exit strategy of the owner (in a privately held firm)
   
   Given the highly complex nature of these issues and the potential for disaster if mishandled, few strongly recommends seeking outside help during this phase of the process.
   
   "Even in large companies, most HR professionals simply don't have the specialized expertise -- much less the time and resources -- to properly address complex compensation issues," he argues. "Executive compensation involves more than just a plan; it's an integral part of your company's overall people strategy. The money invested in outside professionals should be considered an investment in the success of that strategy rather than a cost."


5. Roll out the plan. The goal at this step is two-fold. One, make sure your executives understand the plan in terms of what is expected of them, how it will be measured and how they will reap the rewards. Two, make sure your executives buy into the plan. Depending on the size of the executive team and the complexity of the plan design, a formal rollout can range from a brief one-on-one session to group meetings to a combination of both.

   "If the plan includes long-term incentives based on personal and company goals, bring all the participants together to discuss its operation, reporting and the team-oriented nature of tracking results," suggests Price. "In the group setting, make certain that everyone understands the corporate goals part of the plan. Then meet individually with each executive to discuss his or her personal goals.

   "To buy into the plan, your executives have to believe that you believe in the plan. They have to trust that you will track it and keep them informed of the ongoing results. Use objective measurements, demonstrate that the systems and people are in place to track results, and stick to the plan. When people see your commitment to the plan, it will impact their performance."

6. Monitor performance and communicate results. This represents perhaps the most overlooked step of the process, especially the communication part. After the grand rollout, companies have a tendency to put the plan on the shelf and forget about it until year's end. To counteract this trend, our experts recommend regular communication (quarterly is best) using a mixture of three different mediums:
   
   
   • Face-to-face meetings
   • Print (memos or newsletters)
   • Technology: e-mails and/or Web pages where executives can track ongoing results
   
   "At minimum, you need some kind of annual statement about plan performance, account balances, vesting schedules and the like," urges Price, "but I would recommend doing it more often. Or, make the information available to executives through the Internet. There are several good Web-based programs that can deliver plan information online."
   
   "A good plan can't accomplish much if people don't know about it and understand it," adds Miller. "More than just communicating, you almost have to market the plan to your executives so that they understand it, know where to get their questions answered and appreciate the value the plan holds for them."

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