Incentive compensation management has to be linked directly to your corporate goals

by on June 23, 2009 · 0 Comment POSTED IN: HR Info Center

Balance in long-term incentive compensation management is critical

We had a situation where a company was going through an exit strategy within the next 24 months and historically, the valuation of the company was really driven by the revenue growth. It wasn’t really driven by profitability. The board wanted a budget that was based on a substantial increase in profitability with a really mediocre increase in revenue.

We had to work through that whole situation and say, “Okay let’s change the annual incentive compensation management plan to drive the value of the company” which we finally got there but it was a difficult situation.

The relative value in a long term incentive compensation management system
With long term incentive compensation management, there a lot of companies out there that really messed this up. The situation is as if an owner of a closely held business has a couple of key employees and they’ve given away 40% of the stock ownership to these key employees, the first question we would ask is, “Why?” That’s probably too rich, that’s probably richer what you need to. If it involves succession planning and other things, it may be the appropriate response. That kind of ties into the idea that the managers’ incentive compensation management system is too rich for the shareholders. Sometimes owners willingly give this away without really knowing what is market competitive.

Stock and incentive compensation management systems
We still need to look at our long term and short term incentives to make sure we are truly driving shareholder value. If we look at the balance of short term and long term goals, one of the best long-term incentive vehicles is combination of options or stock. And we can tie it into performance shares or phantom stock or deferred comp. We can tie in a variety of vehicles to drive the value of the company.

But probably the two best are some form of stock ownership or stock options. And we tied that in to an annual incentive compensation management plan. So, if we’re really driving the value based on revenue growth, then let’s reward revenue growth through the annual incentive compensation management system plan. Let’s dole out some options maybe we do a mega grant or a little over reward, so to speak on options.

So that they really feel rewarded to complete the extra strategy at the highest possible price rather than having these disconnects, between, if we complete that, then I probably will lose my job and I only get three months severance and let’s really drive to enhancing the value of the company. So, we have to keep in mind.

Eligibility in a long-term incentive compensation management system
Companies are cutting way back on who gets a long-term incentive. And even in the hi-tech companies, they’re probably looking at director and above in most cases.

So, the days of the all employee stock option and grants or stock awards are moving into the past pretty quickly. I think the latest I saw was about 4% of the companies still do that. But certainly it’s a trend away from that.

The fair market value in a long term incentive compensation strategy has to be considered in light of the valuation of the stock, the valuation of the option, the capital structure of the company.

A lot of times, people look at surveys and they say, “Okay, a CEO should receive a $500,000 long term incentive value.” Well, that may be what the survey say, but is that really appropriate for our company? Because maybe we should only have 15% dilution or 15% over hang and the CEO can’t get all of that and still drive performance to the rest of the group.

So, that’s something we have to tie in, what we have is value equation over here from a market perspective. We have to tie that into what’s appropriate for our capital structure. And we’ll talk about a couple of examples on that.

The incentives for good performance need to also be tied to the market. Again, from good governance practice, we would want to say, if the value of our stock is going up, if we’re publicly traded, that it’s easy to do.

Edited remarks from the Rapid Learning Institute webinar “Incentive Pay Plan Blunders That Can Cost You a Fortune.” By Kevin Nussbaum and Ed Rataj

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