Executive remuneration design principles

Not a week goes by without a new executive controversy erupting somewhere in the world.

Many of these arise from a vocal investor or investor groups, each with their own opposing view as to what is the optimal structure or outcomes of remuneration. Sometimes contradictions even arise from within one investor, which simultaneously attacks a company for not meeting short term TSR outcomes, while underlining the importance of longer-term returns.

Other controversies arise, or are accentuated, by news media hungry for “click-bait”.  There has been an increase in criticism arising from populist politicians stoking the fires of inequality. Activists have become more effective at highlighting the absence of a link between remuneration and broader social and environmental issues, especially in regard to climate change.

Occasionally business leaders poke their heads over the parapet to express concerns on listed companies’ ability to attract and retain directors and executives in a world awash with private equity capital not subject to listed company disclosure and voting requirements.

It is unlikely there has ever been a situation where all stakeholders have been pleased with executive pay. Objectively, there is rarely a 100% correct answer to a given set of challenges.

Part of this stems from the simple fact that every company is different.

Think about it. In addition to publicly-traded, for-profit organizations, there are for-profit companies owned by founders, families, foundations, private equity investors and various combinations of owners. There are co-ops owned by their customers or suppliers. There are a wide range of non-profit organisations, including health care providers, academic institutions and associations.

Each has its own purpose, mission, strategy and set of constituents it serves. In providing services to all these organisation types over the years Guerdon Associates is not a stranger to the concept of an organisation that serves multiple and different stakeholders and requires a tailored executive remuneration structure that best serves their needs.

Nevertheless, there are four overarching principles that all organisations can apply to ensure executive remuneration serves the needs of stakeholders, and is fit for purpose. To that end, we have condensed these principles into the checklist below:

1 . Purpose: Executive remuneration programs must be aligned with, and promote the achievement of the organisation’s purpose. Go further if you like to include mission, strategy and objectives. But if you want to keep it simple, just compare the extent that the remuneration supports the organisation’s purpose.

2 . Alignment: Executive remuneration programs should foster alignment between the interests of a company’s management and those of its owners and other stakeholders. Management are agents for owners. Agency theory says that they will serve their own interests above that of the owners. The job of a board remuneration committee (in fact one could say that this is the sole purpose of the remuneration committee), is to monitor and manage these conflicts of interests. Ensuring executive remuneration is aligned with those of owners and other stakeholders is, arguably, most of the battle. Again, go further if you like to seek alignment among employees at multiple levels and across business units and geographies. But if you want to keep it simple, just compare the extent that executive remuneration is aligned with the interests of owners (primarily) and (increasingly) other stakeholders.

3 . Accountability: Remuneration and incentive programs are a core part of the accountability structure of most organisations.

Unfortunately they often stray from this concept so that people either:

  • get paid for outcomes they are not accountable for, or
  • do not receive a payment aligned to their level of achievement in the areas for which they are accountable.

Sometimes, as many banks found when trying to implement the accountability mapping requirements of the BEAR legislation (see HERE), no-one was directly accountable for anything to do with the organisation’s purpose (or anything in particular in a few cases).

Incentive payments are the primary means by which goals and objectives are communicated and people are held accountable for their achievement. That is, the organisation values what it pays for. So make people accountable, and pay for it.

In listed companies this now goes both ways. Unless programs employ consequence management to reflect reality and include downwards adjustments when appropriate, the credibility of the incentive framework is lost.

4 . Engagement: Remuneration is a powerful tool to communicate what is important and motivate desired behaviours and results. Any successful executive remuneration scheme requires the board to engage with executives for a shared and mutual understanding of these requirements and the resulting rewards. If the remuneration and incentive program is competitive, meaningful, understandable, valuable, consistent, transparent, fair, and tied to achievable yet challenging objectives for which people are accountable, there will be increased motivation and reduced misunderstandings.

Look at your organisation’s executive remuneration against these 4 principles. We trust it will be helpful.

© Guerdon Associates 2024
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