Executive compensation is sometimes called the “third payroll,” says consultant David Wudyka. There’s a general compensation strategy for exempt and nonexempt, but execs are paid differently, he adds.
There are different types of incentives for executives, and taxation becomes increasingly important in compensation planning, says Wudyka, who is managing principal of Westminster Associates in Wrentham, MA. His tips came at a recent BLR/HRhero-sponsored webinar.
Motivating Executives Is a Challenge
Motivating executives is a challenge, says Wudyka, because their level of base compensation is so high, you need different strategies to motivate them. During his presentation, Wudyka offered tips on several key strategies and concepts related to executive compensation.
Egalitarianism
The notion of egalitarianism is an outgrowth of 1960’s/1970’s antidiscrimination laws and their influence on compensation design. With the laws came the belief that it would be safer to design compensation programs in a way that indicated that we were paying people more alike.
A common first jumping off point for egalitarianism is the ratio of executive pay relative to the pay of those lower in the organization.
The concept is good in theory and principle and philosophy, says Wudyka, but it often weakens the company’s ability to attract good people. Ben and Jerry’s Ice Cream was a famous example of egalitarianism. Top executives were paid seven times the pay of the lowest paid people. (One recent study put the ratio in today’s companies as 325! says Wudyka.)
Wudyka’s recommendations generally run counter to the old egalitarian approach. He advocates differentiating executive compensation from other payroll levels.
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Motivating Top Executives
Incentives for top executives must be stronger than those for those at lower levels, since most of their needs are met with generous base pay, says Wudyka. He quotes one expert, Graef Crystal, as saying that a minimum 40% bonus level is necessary to motivate top executives.
To “attract, retain, and motivate” (ARM), says Wudyka, use aggressive levels of pay, benefits, and perquisites. You must know your competitive market levels. If you are not using surveys now, Wudyka encourages you to participate in one or buy one.
Equity and Ownership
One of the primary incentives for executives is ownership through stock. The general thinking is that owning stock strengthens “ownership” thinking, and the more you own, the more you are likely to “invest” in your company’s success, says Wudyka.
Measuring Performance of Executives
Although stock value is commonly used, says Wudyka, it is not ideal. It is much too volatile, and it doesn’t always reflect true growth.
Wudyka recommends that employers consider plans such as EVA (economic value added) or SVA (shareholder value added) plans. Another option, typically used in sales is the override, that is, where the manager at the next level or two up from an incentivized worker gets a percentage of that worker’s total sales.
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Economic Value Added (EVA) and Shareholder Value-Added (SVA)
EVA and SVA are better ways than stock to measure performance of top executives, says Wudyka. Both measures progress made relative to the cost of capital. The measures are often based on a 5-year period.
Many organizations gear incentives to a one-year period, but that often isn’t the best approach for the company. It encourages executives to focus on the short term. They are not likely to invest in something with a 3, 4, or 5 year payoff period, even though that might be clearly the best solution for the organization, when their incentive is based on one year’s results.
Gainsharing is another approach that some organizations use. At the very highest levels of compensation, executives can’t participate directly, but the can be recognized because eligible participants have achieved their goals.
In tomorrow’s Advisor, more on executive compensation, plus an introduction to a special guide for smaller, or even one-person, HR departments.
“Motivating executives is a challenge, says Wudyka, because their level of base compensation is so high …” There’s something very wrong about that statement, true as it may be.