Compensation packages have an incredible impact on the company. When the packages are carefully designed and aligned with the behavior of people with the company’s strategy, it improves performance. When they are managed poorly, be prepared to see devastating effects in the form of demotivated employees, higher turnover, misaligned objectives, and more. The stakes are high, hence, the top management must revisit its talent acquisition strategies and get compensation right!
To drive performance, the leaders must establish clear strategies and understand the basics of compensation and how they are linked to the desired performance outcomes.
Four Dimensions of a Compensation Package
Setting compensation packages is a complex activity. Benchmarking the compensation packages of your competitors doesn’t guarantee the achievement of a certain outcome. There is a pressing need to reevaluate the incentive program and create metrics that serve the interest of your stakeholders in a more meaningful way.
There are four dimensions for analyzing a modern compensation system. Let’s review them:
1: Fixed Versus Variable
Here, the compensation is composed of a base salary, short-term and long-term incentives. These incentives are variable and are contingent on the achievement of individual and organizational goals.
The employee is awarded on the basis of a pre-established formula. The fixed and variable components are driven based on the company’s size, industry, risk appetite, culture, and some other factors.
Telecom, energy, and tech companies pay a higher percentage of variable compensation whereas materials, financial services, and utility companies pay a higher percentage of fixed compensation.
2: Short Versus Long-Term
It’s the second dimension whereby variable compensation is paid in the year it’s awarded or it’s deferred and paid in the future. In this case, the cash reward is pre-established and it’s awarded based on meeting future challenges. Short-term variable compensation takes the form of cash whereas the long term is delivered through instruments like performance shares or stock options.
Companies with multiple overlapping cycles or less cash at hand choose long-term compensation. On the other hand, companies that are going through transformation choose short-term compensation. The makeup of the compensation is to be determined by the company’s compensation strategy.
3. Cash versus Equity
41 percent of the senior executive compensation is paid in cash whereas 59 percent is paid in equity. This mix is determined by the business maturity. New companies normally rely on quality for attracting and retaining their key employees if they are short on cash. Large companies have a higher percentage of equity compensation. Examples include healthcare, technology, energy, and telecom companies.
Equity compensations encourage the company executives to think like owners. It’s obvious, the ones who have a sustainable stake in the company are more inclined to do the right thing. Their goal is to grow the value of the business because it grows the value of the equity and hence their compensation. The CEOs with a smaller stake prefer cash compensation.
4. Individual Versus Group
On average, 29 percent of the company’s compensation is based on individual performance and 71 percent on the performance of the company. The culture and values of the firm impact the amount of compensation as well. Companies with an emphasis on the “I” approach have a higher degree of personal accountability with the results. These companies are human capital-centric and extremely competitive.
Then some companies focus on the “We” approach. They focus on organizational results which are mostly shareholder returns or financial goals. In companies like these, performance is stable as well as predictable.
Building a Compensation Package
A good compensation system starts with the strategic goals of the organization. If the compensation doesn’t align with the organization’s goals, issues emerge. At the time of contemplating compensation programs, you must answer the following questions:
- How does the business strategy reflect in the compensation program?
- Are right metrics being used depending on the current circumstances?
- Does the existing program need redesigning?
- When is the right time to deviate from the norms?
Each company has a unique situation. Some are striving for profitable growth, amid a transformation, trying to compete with a private entity, and the situation goes on and on. Each situation depends on a different plan. The economic crisis brought by COVID has forced companies to alter their compensation plans.
When the pre-set targets become unachievable, incentives automatically lose their power. This is a sign they need to be revised. When this happens, an organization must take the opportunity of measuring the best interest of all the stakeholders.
Leaders need to realize the importance of their role in setting the right compensation packages to ensure employees and others stakeholders stick with the firm and achieve business outcomes. They must have a look at the data on executive pay and gather other business insights to set the right compensation criteria.