Why Do We Do This?—The Principles of Effective Executive Pay Design

Why Do We Do This?—The Principles of Effective Executive Pay Design

As pay-plan designers we are often caught up in the methodologies and nuances of creating effective and enduring executive-compensation plans. From time to time, it is good to push back from the word processor and spreadsheets and try to remember what we are actually trying to accomplish.

I was reminded of this recently when speaking with a client regarding the objectives to be accomplished with the design of a new executive-compensation plan (and pay strategy). In that discussion, I outlined a set of design principles that I believe must be universally applied to the design of any executive or other employee compensation plan.

Let me share my four principles (with a perspective toward executive pay) with you:

  1. Linkage—the interests of the executive team and ownership must clearly overlap and be joined;
  2. Consistency—there must be reasonable consistency in the application metrics, payouts and methods across and among executives and units. However, there can be great differences between business units and executive roles that must be recognized. Further, senior-executive pay models and templates must be usable to develop broader variable-pay reward systems and practices for lower-level managers and professionals.
  3. Sustained performance—true increases in value are the result of sustained operating and financial performance as well as growth. Care must be taken to assure that executives are encouraged to take the long view and not just maximize and be rewarded for today’s actions.
  4. Fairness—all pay arrangements must be perceived as fair and financially equitable to both participant and the shareholders. Further, executive-compensation systems (and all compensation systems) must be – and appear to be – competitive with market practices to be effective.

While the above comments have been tailored to senior executives, we believe these principles generally have application to all employee groups.

When we create or revise an executive or other type of incentive plan, the above-stated principles are the first (and last) best-practice benchmarks to which we refer during the design process. Are there other principles you have or would apply?

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