Changes in global economic policies, regulations, expectations of shareholders, changing business and talent priorities are triggering changes in Global Executive Compensation plans. How can organisations arrive at effective executive compensation plans that increase shareholder value in the long term?
In an insightful session at People Matters TRWC 2021, Madhav Keswani, Group Head - Rewards and Benefits, Aditya Birla Group, shed light on the new trends and ways in which most successful companies are addressing the emerging priorities of the new world of work.
Here are a few excerpts:
Purpose of executive compensation is to maximize shareholder value
Different life stages of the organisation need leadership to focus on different objectives. For instance for startups, it will be new concepts and models, identifying new markets and customer segments, and developing capabilities to execute. In the growth stage, there will be increased emphasis on margins and market share. As the organisation further matures, the focus shifts to cost and efficiency. So what makes substance of the company in the long terms is the role senior leadership plays in delivering value to shareholders. Executive compensation should influence decisions and behaviors that result in value creation. Ultimately, the purpose of executive compensation besides attracting and retaining the right leadership talent is to maximize long term shareholder value.
Executive compensation is also related to the maturity stage of the organisation. In a startup, the compensation structure is based on low cash component and a higher equity portion to represent the frugal nature of the business and align the interests of the leadership with the growth of the company. In the growth stage, there is a healthy mix of fixed component, annual incentives, and relatively higher focus on long term incentives. But with stages compressing, organisations are moving through the life stages much quicker. So how do you explain some organisations staying in the growth phase longer?
Rewarding success over the long term
When one looks at high growth companies like Meta, Apple, Amazon, Microsoft, Apple, Tesla, and Google, one realizes that compensation plans do not work in a vacuum and work best when they are aligned with its culture, purpose, values, and leadership vision. For instance, early at Amazon, Jeff Bezos spelled out that the fundamental values of success is the shareholder value we create over the long term. The company aimed for market leadership, customer and revenue growth not profit. The compensation structure at Amazon consists of only two components- a modest base salary and restricted stock units that vest over the long term. The structure is designed to encourage innovation and long term thinking. There are no performance goals tied to cash or equity compensation. This encourages the entire management to focus on only one metric-shareholder value creation over the long term.
Tesla also follows a similar structure of base salary and stock options, which are granted at the current market price. If the market price stays flat or goes down, the executives make nothing. Similarly, the stock options for the CEO additionally have performance conditions attached-such as market capitalization growth and total revenue and EBITDA milestones. This focus on long term and innovation by these companies is being rewarded by the market as can be seen in their market capitalization.
Linking ESG with executive compensation
If one looks back at the financial crisis of 2008, executive compensation stood out as the deeply flawed element of the incentive system that induced firms to accumulate enormous amounts of risk in their balance sheet. That time, executives were able to pocket bonuses based on short term results. Since then, various sound practices for effective compensation governance have been put in place. In the future, ESG will no longer remain a buzzword. Investors are realising the importance of sustainability, risk, social metrics, and social impact of decisions that can cause serious financial implications. Regulators across jurisdictions are mandating disclosing ESG disclosures and there is an increased talk of linking ESG to executive compensation. Hence the future will witness a greater focus on ESG metrics as they get integrated with the overall business process and strategy and linkages with executive compensation will emerge.
Ultimately, organisations need to be curious of their own business, their own culture and values that they want; emerging regulations on ESG and what’s happening across different sectors and geographies; their long term objectives and how is the executive compensation plan designed to achieve them; how are executive compensation metrics cascaded to the rest of the organisation, and what behaviors will these metrics incentivize and are there any unintended consequences of it. All of these questions, though uncomfortable, will help us land at better solutions and will be appreciated by our stakeholders and the market in the long run.