| When a company experiences a decline in its financial | | | | realizing the importance of some form of equity |
| numbers, the finger is often pointed at the easiest | | | | compensation within the compensation package in |
| culprit: the compensation plan. The "plan" lacks the | | | | order to compete with their public counterparts. |
| motivational effect desired, or the plan does not | | | | Once the compensation package mix is determined, |
| focus attention on desired behaviors; or the plan isn't | | | | the company should decide on its intended Executive |
| retaining the company's key people. So you consider | | | | Compensation Philosophy, which will serve as the |
| a redesign. But putting a new plan in place doesn't | | | | reference point for evaluating the current program |
| necessarily guarantee it will work any better than its | | | | and designing the new pay program. |
| predecessor. Often, the plan is developed with little | | | | Step 3: Develop a Draft Plan |
| time, foresight, analyses or attention on the key | | | | In this step, the parts come together to create a |
| issues that can significantly impact the ability of the | | | | plan that will support the organization's Strategic |
| plan to succeed. The fact is, plan mechanics aren't | | | | business Plan in the most effective manner. The |
| usually to blame for the plan's malfunction; there are | | | | parts include: |
| inherently internal issues that affect the ability of the | | | | · Participants |
| plan to focus attentionon the right activities. The | | | | · Basis for payment of awards (performance |
| problems typically fall into three main categories: | | | | metrics and weightings) |
| 1. Overly Complex Plan Design. If you want to | | | | · Form of payment (cash, stock, or |
| guarantee the demise of executive compensation | | | | combination) |
| plan, make it difficult to understand. Plan "designers" | | | | · Timing of awards (current year, defined |
| often tend to try to accomplish too much within the | | | | performance period, career-based, or deferred) |
| plan in order to satisfy all of the parties involved, but | | | | · Setting and performance targets and |
| the irony is they end up not serving any aspect of | | | | thresholds |
| the business very well. Or they try to address every | | | | · Award determination and funding |
| possible performance scenario and put in so many | | | | · Rules for administering the program |
| caveats that it leaves heads spinning. To alleviate this | | | | The plan should be designed with a degree of |
| issue, follow the "KISS" adage - Keep It Simple, | | | | flexibility to recognize changes in business strategy, |
| Stupid! | | | | so that the entire plan need not be changed in this |
| 2. Administration Gridlock. When plans are overly | | | | event. A key element of success here is to design a |
| complex, they can be very difficult to administer on a | | | | plan that has a clear focus for the achievement of |
| timely basis. Often, the complexity also adds an | | | | the company's goals, based on a consensus among |
| element of ambiguity, because it is difficult to define | | | | the Board and Top Management. |
| all the scenarios and caveats of a plan when you're | | | | Step 4: Modeling the New Plan |
| are dealing with a multitude of layers and too many | | | | To anticipate how the plan may operate once |
| variables. When administration becomes difficult, plan | | | | implemented, the company should conduct a cost |
| participants can begin to question the plan's | | | | benefit analysis to see how the executive will be |
| administrators - and ultimately lose faith in the plan | | | | rewarded under different performance scenarios. If |
| itself. | | | | they are performing at their level of expectation, |
| 3. Unclear Goals. When an executive compensation | | | | they should be paid at the right level (typically at |
| plan is too complex and hard to understand, it | | | | market), and vice-versa. A well-designed plan that |
| become even more difficult to explain to the | | | | was sufficiently modeled will help to motivate and |
| participants - the executive loses focus (since they | | | | retain a company's key executives, and should also |
| cannot understand the plan or what the company | | | | spotlight (and possibly eliminate) weaker members of |
| really wants) and, in effect, their motivation is | | | | the executive team. |
| reduced. Many companies devote considerable time | | | | Step 5: Implementation and Administration |
| and resources to developing compensation plans, | | | | Putting a new plan into operation requires a good deal |
| then fail to educate their executives about their | | | | of work and thorough communication, including a |
| compensation plans or adequately communicate their | | | | strong message from the Board top management |
| goals and objectives. As a result, the company may | | | | that they unequivocally support the plan. This goes a |
| find that the executive are unable or unwilling to | | | | long way ensuring that participants understand the |
| meet the performance metrics set forth by the plan, | | | | organization's commitment to the plan's success. |
| so they continue on a course that doesn't reflect the | | | | Communications should be targeted to the |
| appropriate business direction or realities. | | | | participants themselves, as well as the corporate |
| A Systematic Approach | | | | staff that's responsible for plan's administration. The |
| To avoid the need to continually reexamine the | | | | form of communication should vary for each |
| executive compensation plan, it is important to | | | | audience, since each group has to understand it in a |
| dissect the plan (and its inherent problems) in order | | | | slightly different way. |
| to attempt to develop one that really works. Using a | | | | When installing a new plan, careful attention should be |
| systematic process for assessment, design and | | | | paid to identifying and addressing transitional or |
| administration will help to eliminate some or all of | | | | phase-in issues, so as to not rankle the participants or |
| these issues and help you implement an executive | | | | demotivate them. Processes to transition to the new |
| pay plan that will be far more effective at meeting | | | | plan could include running parallel systems, |
| your company's goals. | | | | grandfathering some performance objectives and |
| The following six-step process may be followed for a | | | | other related issues. |
| systematic approach to plan design: | | | | To ensure smooth implementation of the program |
| Step 1: Clarify the Company's Strategic Business Plan | | | | and keep executives focused on desired results, an |
| It is not unusual for a company to attempt to design | | | | active system of communication and feedback should |
| a new compensation plan without having a consensus | | | | to continue to focus the executive's attention on the |
| among the Board and top management as to where | | | | desired results, an active system of communication |
| their focus should be, which performance goals to | | | | and feedback should be established (obviously on a |
| emphasize, and (in some cases) what the role of the | | | | higher level than with programs covering the rank and |
| executive should be. In order for the plan to be | | | | file). |
| effective, these focus items must be identified and | | | | Top Management, the Compensation Committee and |
| prioritized. This strategy should be used in defining | | | | the Board should take the time to review |
| the concepts for the new pay plan. | | | | performance against goals on a periodic basis so that |
| Step 2: Determine the Desired Mix | | | | they can identify areas for corrective action before |
| The design of the executive compensation plan | | | | the damage is done. Such a system continues to |
| should begin with a determination of what the | | | | reinforce the company's commitment to the plan's |
| reasonable and appropriate compensation package is | | | | success and can enhance the executive's motivation |
| for the company's executive positions. This should be | | | | and performance. |
| based on reliable market data from the company's | | | | An executive compensation program requires a |
| peers and industry segment(s) against which the | | | | significant investment of time and resources; an |
| organization measures itself. In addition, the degree | | | | appropriate communication mechanism will enhance |
| of variability should be defined - that is, what will be | | | | the plan's ability to accomplish its objectives and will in |
| the mix between fixed pay (salary) and variable | | | | turn benefit both the organization (in increased |
| elements (consisting of short- and long-term | | | | performance) and the executive (with awards |
| incentives)? | | | | commensurate with that performance). |
| For public companies, the mix tends to be more | | | | Step 6: Monitoring and Corrective Action |
| heavily weighted toward variable compensation, | | | | Once the plan is implemented, it will be easier to tell |
| (including the use of stock-based awards), since | | | | how effective it will be at focusing executive's |
| equity is readily available, although the nature of the | | | | attention on the desired results. If the results don't |
| awards is shifting from stock options to restricted | | | | match up with expectations, the company needs to |
| stock units, restricted stock, stock appreciation | | | | find out why and take remedial action. Be careful not |
| rights, and other programs. For privately held firms, | | | | to throw the baby out with the bathwater; redesign |
| the emphasis is typically on cash-based capital | | | | is an on-going process that must be carried out on a |
| accumulation, however, many private companies are | | | | timely and continuous basis. |