Do compensation consultants help price CEO compensation more accurately or worsen it?

This is a great question. The truth is the compensation consultants do some of both.

The form of this question seems to presuppose that “accurate” and “worse” are different outcomes. In the world of compensation they often are the same thing.

If a company determines that it must pay their CEO in the 75th percentile in order to get the quality of executive that will best serve the needs of their shareholders then they will look to market data from peer companies (easily accessible for public companies) and determine the 75th percentile.  This sets the basic pay level.  Easy peasy except for a few little things…

If everyone decides they need an executive in the 75th percentile and everyone is looking at the same data and the data is updated every year, then the 75th percentile will also rise every year.  Perfectly accurate and inarguably worse.

If the peer groups selected are just 10% better than a “real” peer group of similarly performing, sized, etc. companies then the compounding factor above is made even worse.  Still totally accurate, but not any better.

If the stock market drive upward at a rate faster than initial predicted the compounding factor can be even worse (You Get 2 Shares and You Get 4 Shares and So on and So on…).

But, if you take a look from another perspective you may see a different picture. Investors are all about making money. If I told you you could make $1000 by paying someone $500, or you could make $400 by paying someone $300, you would probably choose to pay $500 and get the bigger payoff. In this case (and this perspective) the higher pay is better. It is also accurate.

All of that being said there is some academic research on this topic.  A good start is here.  Page on northwestern.edu

Executive Compensation: How do companies determine their upper-management pay structure?

Executive pay structure involves determine that compensation elements (tools) to be used and the levels or amounts for each.

The best way to accomplish this is to first determine a compensation philosophy. This defines what you are trying to accomplish with pay, the basic levels of pay as compared to the market, peer companies to use as comparison, the type of consistent, variable and very long-term pay and much more (Executive Pay Can’t Be Fixed! But….here are 3 things to consider.)

Then the company will review market data for the pay types and levels of relevant peers. These become data points for the comparison against the companies stated compensation philosophy.

In best cases modeling is done to determine worst case, best case, mathematical and “gut check” scenarios.  The company then balances these and sets pay levels and types for each individual.

The process is part science, part art and a bunch of pseudo-science. The end result is generally fairly acceptable and defensible.  As companies get very big the data and approach sometimes breaks down, but the high levels of pay you see are usually not because of this breakdown.

The high levels of pay are because everyone would rather wait and pay executives (usually through stock) than guarantee them cash up front. And the corporate tax rules support this.

Let me know if you need more…

Tipping Points – 5 for Pay Professionals

stickman Pay Tipping Point“The moment of critical mass, the threshold, the boiling point.1” This is how Malcolm Gladwell describes the tipping point. It is the moment when things truly change and return to the prior state becomes hard, or even impossible. Responding to major changes like these tend to drive evolution or revolution. The results can be more volatile than expected and occur more quickly. There have been many compensation-related changes happening over the past couple of decades. I make the case for five elements that may be nearing a tipping point.

1. Pay for Performance.

Pay for performance is incredibly popular right now. I am one of its biggest proponents. But, as the use of P4P rises, so does the lack of verification of effectiveness, structure and communication for these programs. There is real potential for the abject failure of these programs as a whole. P4P is filled with potential risk. Failure will likely be seen in angry employees and struggling companies.

2. Pay Disparity.

It has been almost one hundred years since we have had wealth disparity in the United States like we are currently experiencing. Not all of the disparity is driven by pay, but as the wealth gap has grown, so has the pay gap. We are already seeing attention from the media, scrutiny from the government and discontentment among employees. While the first two get the most attention, it is the employees who will drive the tipping point. Unless they are given some path to correction, they will find a more volatile way to drive change.

3. Retirement Shortfalls.

The way we currently look at retirement has been around for just about the same amount of time as our oldest citizens. These senior people had a lot of help in preparing for retirement and we still have huge problems with poverty among the elderly. It is expensive to be alive. The shortfall between retirement funds versus needs has been well documented. We have built a society where people live a long time and can do so knowing that they are supported by funds that were designated long ago. As retirement funding changes and social security fails to keep up with the cost of living, will we see new “families” where employees spend as much time and effort supporting their parents as they do their children? Can the two-income work structure we have built support this additional need for time and money?

4. Pay Survey Use.

Pay surveys are useful ingredient in delivering proper pay. But, like sugar, overuse can be unhealthy. The flaws of the data and how we use it have been documented for years. Search on the term “survey” on this site and you will see what I mean. Pay surveys help make our decisions “feel” better. Sometimes at the expense of them actually “being” better. Are we prepared for the moment when the overuse of surveys becomes a rallying cry for those people outside of our profession?

5. Equity Compensation.

Many of you know that I believe equity compensation is an incredibly important element of pay. But, like other forms of pay for performance, it has often been used without a thorough understanding of its impact. The growth of equity compensation easily aligns with the growth in executive / employee pay disparity. Pay disparity is itself nearing a potential tipping point. Without thoughtful planning and better use of equity compensation, we may see it disappear like so many other formerly useful pay programs (defined benefit plans anyone?).

1 The Tipping Point: How Little Things Can Make a Big Difference

 

Beware of Statistic Laden Compensation News

Stickman Beware of Stats and NewsWe love data. In fact, compensation professionals seek out data like artists desire southern exposure in New York or kids crave waterslides in the summer. Data is our friend. It helps guide us and it provides credibility for our decisions. But, we must always beware of prepackaged data. This type of data is our “frenemy”. It gives us hope or makes us feel confident, then pokes us in the eye.

Take for instance the recent announcement that 43% of employees would take a pay cut in return for a better company 401(k) match. The subheadings for these articles cited a report published by Fidelity. Fidelity is a well-respected source of 401(k) data. What could be wrong?

Well, the report was based on more than 1,000 employees who were still working and were actively contributing to their retirement savings. While this does qualify as “more than 1,000 employees” it’s not representative of 1,000 employees at any one company I have ever heard of.  That’s like saying, “We took a survey of 1,000 people and 100% agreed that ice cream was one of the best things ever on a hot day.” While not telling people that you took the survey at the exit door of an ice cream store on a hot, humid August day.

The reports on 401(k) (herehere and here) went on to discuss that the average company match was about $3,540. Average of what companies? Average of which employees’ contributions? The reports do not specify. Most also mention this amount is $1,000 more than 10 years ago without mentioning of “why”. Could it be that people are paid more than a decade ago? Maybe the companies in the survey offer better 401(k)s now, but have cut short-term incentives, long-term incentives or other benefits. We simply cannot tell from the information provided. Only after reading multiple articles do we learn that Fidelity reports that the average employer contribution is currently 4.3% per year vs. 4.0% in 2006. So, no big change there.

But, it’s not just those of us working in compensation that gets caught in this trap. Sometimes it’s the people we pay. A friend who was laid off a couple of months ago has had a difficult time finding work in her chosen field. She sent me a note the other day with a link to an article on AOL that “supported” the incredible lack of full time jobs. Those of you who jumped ahead and opened the article will see that it discusses the fact that only 1.3 billion adults worldwide have full time jobs. Specifically, one in four adults globally had full-time employment last year.

My friend was focused on the fact that 75% of people did not have a full-time job. And, she was part of the growing 75%. No real thought went into how many people in the world are too old or too young to work. What about the demographics of the other continents? And, then there are the rural poverty-stricken parts of India or China that assuredly play into this global statistic.  She gave no consideration into how many of those people lived in places where full time jobs have nothing to do with a “chosen field”. No thought went into that fact that she lives in New York City a place with less than 8% (not 75%) unemployment.

Now you might say that my friend is not the smartest cookie, but would you also say the same about compensation professionals who believed the reports on 401(k) match? Or perhaps, in a world and workplace swimming with data, statistics and ready-made sound bites, do we all get caught in the trap of easy-to-access information? Just remember: If you see percentages, ratios or hard numbers in an article, beware. You might be seeing a journalistic or marketing artist’s surreal masterpiece rather than the facts.

Dan Walter is the President and CEO of Performensation and is committed to aligning pay with corporate strategy and culture. Download the “Equity Compensation Design and Use Matrix.” Dan has co-authored several books including “The Decision Makers Guide to Equity Compensation”“If I’d Only Known That”“GEOnomics 2011” and “Equity Alternatives.” Connect with him on LinkedIn or follow him on Twitter at @Performensation and @SayOnPay.

What’s an alternative to equity based compensation that recruits, motivates and retains employees?

Q:  I plan to bootstrap and keep my company private with no plans on selling. What’s an alternative to equity based compensation that recruits, motivates and retains employees? Should we increase benefits?

Dan Walter’s Answer:

Equity compensation serves a purpose as a Long-Term Incentive. Alternatives include long-term cash (including performance-based cash), higher base pay, some form of profit sharing (although perhaps not a formal “profit sharing plan”) and synthetic equity.

Research shows that benefits generally have little impact on recruiting and motivation. They can be effective bolstering retention.

The first question I would ask is what do you believe equity compensation is intended to deliver? This will help define the hole you are trying to fill with one or more alternatives.

Also, remember that there are key benefits to equity that most other tools cannot provide. Among these are potential tax planning strategies for participants, and creating a low, fixed compensation expense for the company. There are, of course, downsides as well (like communication issues), which I would be happy to go in a different forum.

Short-term incentives may also serve your purpose, if they are structured well.

Lastly, I would ask why you DON’T want to use equity compensation. There are many legitimate reasons, but I find that many companies avoid this tool because of myths and misunderstanding.

Follow the full Q&A on Clarity.fm here

Too Successful for Incentive Compensation

Stickman Too Successful for Incentive PayCompensation professionals have a basic mantra: Attract, Motivate and Retain. It is the basis for many companies’ compensation philosophies. It is included in a majority of public companies’ CD&As (Compensation Discussion and Analysis). It is foundation of countless sales compensation programs. But, what if your company is just too darned good?

I am currently working with a company in exactly this situation. Their product is so popular they simply can’t make enough of it. Their sales team is so effective that they have sold everything possible and still have consumers knocking on the door for more. It sounds great, but it is truly a problem.

Like many companies in the retail world, supply and demand doesn’t drive their prices. A larger pricing structure exists for their industry. This means that they can’t make more money just because people love their stuff. It also means that their incentive compensation programs have a conspicuous hole.

Sales people are often referred to as “coin operated”. This can be a great thing. As long as your products are strong and your company is fairly successful, paying sales people is competitive but predictable. But, what if the coin was taken away?  The calculation becomes far different.

A company now must find a way to keep people producing when their main source of motivation and money offers no additional upside potential until after the end of the year. Success has its downsides!

Wait there’s more! Because revenues are essentially capped for the last couple of months of the year, the company won’t have additional budget to build a significant short-term “bridge” into next year. And, of course, the market is hot and competitors are continuing to call.

It is now here where the overall strength of your total rewards and human capital package become SO ESSENTIAL. This company has a great internal culture and it offers long-term incentives and ownership. It even has great programs that augment pay. The company prides itself in being a place where people want to come to work. It values its employees in ways that not only cost money, but require a little more time, effort and understanding.

Because the company has communicated a strong long-term strategy and has been built on a powerful internal culture, this company has an impressive foundation and useful tools to help keep employees engaged and retained during this fantastic albeit rough patch. If they had not spent the time and money over many years to build that holistic package, these critical team members would probably be the first to leave.

Compensation isn’t the be all and end all of everything. When it breaks, and it will someday, your foundation had better be strong enough to fill the hole until you can correct the problem.

Pay for Performance Lessons from the Tour de France

Stickman Tour de France P4PThe 2014 Tour de France is 2276 miles (3664 K). It is a grueling race that covers 21 stages that include mountains, hills and flats. The “winner” is the individual with the lowest total time at the end of the final stage. How they accomplish this goal is very enlightening and applies directly to pay for performance and corporate culture.

Every rider is part of a team. Every team has a designated leader. The leader is generally very good at multiple disciplines, while other team members may have specific skill sets that are important during different stages. The final trophy is presented to an individual, but no one rides alone.

Like the employees at most companies, many of the team members work hard but are fairly anonymous. And like corporate executives, the lead rider gets most of the glory, money and fame. The top riders on each team can make more than $1,000,000. The average salary is around $200,000 and there is even a mandatory minimum wage of $52,000. In addition to these amounts, there are performance bonuses, appearance fees and other considerations. So, in general, the riders are paid much like employee of most companies.

Individual performance is lauded. The specialist riders have specific goals throughout the race. The sprinters, hill climbers and young riders all get recognized from day one through the race completion. They compete in races within the race even as they help their teams.

We all know it can be hard to see how each employee contributes to the success of a company. The Tour de France is great because the teamwork involved in winning the Tour can be easily seen every mile of the race. The teams mostly ride in groups to make the race easier on the team leader. They protect the key players and they allow for a team to control the pace of the race. When everyone is riding well it is similar to an effective software development or manufacturing team. It’s when things go wrong that we see our real pay for performance lesson.

When an average rider crashes or has a mechanical problem, they can quickly fall behind the peloton (or pack of riders). The lower level riders may get help from a teammate or may be left to work their way back to the team. But, when a team leader goes down, a multi-person escort immediately falls back to ensure their path back to the front is as easy as possible. Yes, this is the guy who is paid the most, but he is also the guy who is most likely to get every team member a win. There is a team manager riding in car who decides who gets help and how much help will be given.

Rather than build an all or nothing environment where an individual must perform perfectly or be left by the roadside, the teams understand which individual gives them the best chance to win. As long as the team leader provides them with the best chance in the long run, the team will do anything to support them. As pay for performance becomes the new normal this is a lesson we must all remember.

Designing a plan that pays all or nothing creates many issues. It magnifies a single failure into what may seem like complete failure. It can leave an individual feeling like they have no support to get back to the front, even when they provide the best chance for everyone else to win. It can inspire people to display bad behaviors. The leaders may “bend” rules in order to win. The next layer of players may be inspired to sabotage the leader to capitalize on their own opportunity. In long-term incentives, the focus on the end of the race can distract from the day to day strategy and tactics required to stay in contention. In short, providing for small wins and measured success along the road is a far more effective way to win a race.

The Tour’s focus on the team work, interim goals, long-term planning and execution make it a great example of how to do many things right. Of course, it has had many ignoble problems over the years, which also shows the need for great oversight and management. Let’s discuss “all or nothing” plans that have worked or failed in your career.

How to reduce dysfunctional peer competition among managers

Question:

I oversee the HR function in a large Process Consulting/ Outsourcing firm. We plan to grow aggressively in near future as our Fortune 500 clients recover from the downturn and initiate new projects.
Our company culture is very performance driven. As we promote our A-players to managerial positions to handle growth, we want to engender in them a spirit of cooperation. We feel this will help us win/ handle more business by coming up with innovative solutions for complex client needs.

How can we accelerate collaboration/ co-operation in these new managers who come from high-pressure single contributor roles?

Dan Walter’s Answer

This is both a simple and complex issue.  Simple, because providing a system of direction and compensation toward a common goal is a must in this situation.  Complex for many many reasons.

The four main considerations of a pay for performance system are:

1) Metrics

2) Goals

3) Communication

4) Human Nature

Good metrics require an understanding of your strategy and culture.  They also require evidence, and not just anecdotal, that the metrics either link to driving performance or are the result of performance.

Good goals require good, and honest, modeling.  Best Case, Worst Case, Mathematically Modeled and Gut Expectations must all be combined to create a range of reasonable and acceptable goals.

Communications are what makes sense of the above. There are many paths to the top of each mountain.  Your individuals and teams may be climbing from different directions but they must all understand that they are headed to the same location. Early climbers must understand that leaving a well set path helps everyone succeed.  Slower climbers must understand that they may need to carry more supplies to provide the early teams with replenishment when they must rest.  We sometimes explain the entire process in the context of the ecosystem of the industry that the business supports. It helps people understand things from their day to day perspective. Imagine a brewery where everyone component of pay and reward is linked back to the types of things the company produces, the people who produce them and the process used to produce them. Even the language used can be similar.

Human Nature is the biggest factor. The program must be able to have multiple aligned and intertwined threads that allow you to explain it from many perspectives. They importance and impact of the program cannot be explained from your perspective and result in any level of success.  It must be able to resonate with each individual.  This is especially true in a professional services organization.  You people are solution providers. They are idea people.  Let them help you craft your solution. If they are involved they will feel ownership. If they are involved it will be hard for them to explain how they “would have done it better.”  This will make the process harder at the start, but must easier over the long run.

A couple of other thoughts:

First, every A player you have is not necessarily suited to be a team leader.  You must be willing to accept the fact that some of your best performers will likely best serve you as individual performers.  For these people providing metrics and goals that appeal to the individual nature (or self-interest) is a must. The onus will be on you to ensure the metrics and goals also align with, or support, the broader group and company goals that apply to team leaders.

For those A players that have the skill set or potential to be leaders of groups you must take the time to clearly communicate what is meant by a leader in your culture. Leadership may come naturally to some, but the combination of leadership and your culture will come easily to almost no one. Give them a strong foundation and follow it with consistent and frequent messaging, additions and clarifications.  Even professional athletes need to be reminded on a regular basis of the “right” way to do things.

Most importantly you must be able to show how individual performance ties to group success and how group success ties back to individual rewards. Be honest and critical when you evaluate your structure and pay approach. Be willing to change components that worked well when you were smaller and more individualistic. Understand the pieces that got you where you are that will also stop you from moving to the next level of your evolution.

We have found that a good approach is to create a group of stakeholders from a level below the top of the company.  Your top leaders are likely to be successful with the old approach and since it worked for them, it may be hard for them to see a different/better way. The next level down is where your strivers exist. This is often where your “culture carriers” make their home.  Most importantly this is the group that will provide the idea that will take you to the next level.

Read the original question on MentorsGuild

The Best Laid Plans of Mice and Compensation Professionals

stickman best laid plans of miceIt’s hard. Sometimes it’s very hard. You took the classes. You studied the facts. You brought in great outside experts. You have determined the solution. You are the expert and you know what you are doing. How can they say no?

“In preparing for battle I have always found that plans are useless, but planning is indispensable.”
Dwight D. Eisenhower

My job is to go into a meeting with the head of HR, a CEO or Board with what I believe is the perfect solution to their problem. “You should get rid of the old XYZ plan and put in a new ABC plan.” Occasionally I leave those meetings excited and ready to act on a very different solution. “Let’s leave the XYZ plan alone for now and work on adjusting base pay and equity for this key group of employees who are critical to the next six months of our success.”

As an HR or compensation professional, even the best plans require the agreement of others. Some of you have taught sessions on how to get a seat at the table. Many have taken courses on how to negotiate, be persuasive or sell ideas. Sometimes that extra chair just doesn’t fit in the room. Sometimes no matter how much evidence you have to support your idea, it simply isn’t going to happen.

This does not make you a failure. It does not make your idea bad. It doesn’t mean that you need to forget your great solution or leave it in the rubbish. It also doesn’t mean that you are done. It is frustrating, but it is nothing more than a temporary setback.

The best plans usually solve more than one problem. An effective approach after losing the first round of discussions is to find the most important (or well-received) nugget in your “big plan”. Polish it up like a diamond and go back in with the idea they can’t refuse.

Even a little help is better than demanding that you get everything you want. If you can’t get that incentive plan budget for the entire staff at least make sure you get something for the group of people without whom you will suffer or fail.

We plan for the opponent we expect, but we must fight the opponent who shows up.

Maybe your board won’t support the mission critical solution your have devised. Instead of waiting until next year and trying again, consider recommending Plan B or Plan C. Have an idea of what these might be, but prepare well enough that you can suggest potential alternatives quickly and thoughtfully.

Instead of getting approval from the top down, you may have similar issues getting buy-in from the ground up. Your employees may not be enamored with the “motivational pay for performance plan” you rolled out with great fanfare. Your sales people may find that the new commission program you designed to fix their complaints about the terrible old plan is even worse.

We often discuss communications as a solution to these kinds of problems. Better communication is always a good place to start, but even best communications can’t solve every problem. Don’t be afraid to regroup, retool and try a smaller, different or less exciting idea. Even the best-laid plans may be useless once the real fighting starts, but even the smallest solutions move you forward, regardless of the plan.

Resources and thoughts on recurring stock option grants?

Question:

I’m currently working on a project for a high-growth, 500 ee company in the tech sector, would like to implement recurring stock grants as a retention strategy. Need information on best practices and creative ideas around vesting schedules, grant timing (annual, bi-annual, promotional, etc.).

Any resources or anecdotal input would be terrific.  I’m familiar with NASPP but am not sure how granular their data cuts are for private and pre-IPO co’s.

Dan Walter’s Answer:

Equity compensation plans are a specialty of mine. As far as data goes for a company your size, in the tech sector, I would probably start with Radford and Culpepper for the granular “comp style” stuff.  The NCEO also has some good information.

The NASPP is likely to have more information for public companies that private, but the details they have regarding features such as termination rules, exercise types and accounting/taxation issues is very useful.

All of that being said, creating a recurring grant program is far more about your companies goals and compensation philosophy than it is about market data. Market data has a difficulty incorporate all of the unique details that make equity compensation compensation programs work for some companies and fail for others.

Most of the survey data you find will show that companies of your size use stock options, those stock options have a four year vesting schedule (25% annual vesting or 25% at the end of the first year and monthly thereafter). They will show values that are related to the price at the time of grant, rather than what is expected to be realized or planned to be achieved.  Data won’t show much about the current trends to RSUs as you get closer to an IPO. The data won’t show the increase in performance unit plans for management and above. The data also won’t show the provisions around change in control or termination provisions.  Most importantly it won’t show WHY the each company made each decision, or whether the decisions turned out as expected.

I would be happy to have a quick chat to point out some of the key considerations regarding putting a program like this in place. I can also direct you to some specific resources once I understand better what your objectives are.  Feel free to shoot me a message, or give me a call 415-625-3406, or contact me via email (dwalter@performensation.com)