Designing an effective remuneration structure that incentivises executives can be a difficult task for boards to accomplish. This article provides a simple checklist. Tick all the boxes and you will not need a consultant.

The checklist has a solid behavioural science background. Vroom’s expectancy theory states “Intensity of work depends on the perception that effort (GA prefers the word “focus”) will result in a desired outcome”. In terms of remuneration, an individual will focus more consistently and effectively on achieving goals when the goal is clearly described and understood, the reward is valuable, the means to achieve it can be directly influenced, and regular and frequent feedback is provided. Add to that some of McClelland’s findings on ‘achievement-motivation’, requiring the goals to be achievable for the person’s competence levels, and that the individual has enough self-knowledge to understand targets are achievable.

So what are the characteristics that make up a well-structured incentive plan? They include:

1. 1. Understanding expectations
   2. Ensuring goals achievable and can be influenced
   3. Having trackable progress
   4. Having a meaningful reward for achievement
   5. Awareness of negative outcomes

1. Understanding expectations

Ensure performance requirements and their measures are thoroughly understood by an executive. If an executive cannot be cognisant of a measure, they will struggle to gauge what is required to attain the attached reward.

2. Ensuring goals achievable and can be directly influenced

Many boards and at least one proxy adviser (see HERE) are inclined to set performance targets that are unrealistic and position payout to begin in a “stretch” scenario. Behavioural science tells us this does not work. Individuals will not try to achieve goals that they believe are unachievable and will ignore them. While McClelland’s work verified that “achievement-motivated people are generally the ones who make things happen and get results”, his research also indicated they have good self-knowledge of their capabilities, and focus on what is achievable.

3. Having trackable progress

It is necessary for an individual to receive frequent feedback on progress. In fact some research suggests that relevant and frequent feedback can have more impact than reward value. Whilst this may be difficult to implement in some cases (e.g. there is often a delay with carbon emission measures), if a metric is important enough to be rewarded, it is important enough to be communicated in a timely manner.

4. Having a meaningful reward for achievement

What is “meaningful reward” varies. And some of the variables may be in the realm of “known unknowns”, such as the assets and other income an individual has. Generally, the lower the base pay the lower the percentage of base pay to get sufficient attention. At executive level count on at least 30% of base pay to get sufficient focus. But even then, think through what is being asked, and the consequences of failure and success. For some employees, it may be safer to the minimum to retain their job rather than stick their neck out and lose all (aka “satisficing – see HERE).

5. Awareness of negative outcomes

The way a metric is achieved is as important as the achievement itself. If an individual is incentivised to cut corners and meet targets at the expense of the company, they likely will. To combat this, deferral of rewards is encouraged, with malus or clawback provisions implemented on top. This ensures that risky or detrimental behaviour is not being rewarded and provides a negative result if undertaken. A similarly effective tool is the use of modifiers instead of measures. For example, instead of including a 10% measure of ‘risk’, consider a modifier to increase or decrease reward based on the degree of riskiness.

Concluding remarks:

Evaluate your current incentive plans. How well do they meet the criteria above? Next is to consider how to tackle external stakeholders who may not be as well informed. See HERE.

 

 

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