Rethinking Incentives for Executives

Some academic research[i] suggests that incentive schemes are well suited to motivate and reward routine work, but no better than fixed salary where the work is creative and non-standard. Perhaps even causing unwelcome behaviours and negative outcomes.
Despite this, short term incentive (STI) schemes for executives are wide spread, with about 94% of USA[ii] and 72%[iii] of NZ remuneration packages containing variable pay elements.

To be effective, STI schemes should:

  • Align reward costs with business results
  • Instil a culture focused on results rather than effort
  • Pay competitively to retain high achievers
  • Increase employee’s engagement (not forgetting spouse’s)

The acronym SMART (Specific, Measurable, Agreed Upon, Realistic, Time-based) is great guidance for goal setting.

But most schemes are crudely targeted, paying on financial measures alone. Earnings (often with Revenue as a second criterion) versus Target, Budget or Last Year predominate as achievement incentives. But financial performance is a lag indicator of executive achievement and value creation. The business must have attained strategic health and operational fitness before the bottom line confirms it. Lead indicators of success generally include: –

  • Brand and Reputation Development
  • Customer Satisfaction
  • Team Building and Engagement

to which could be added Best Practice Systems and Processes, New Product or Channel Development, Transformation or Disruption Success, Project Delivery, or a Learning Organization, depending on the imperatives currently facing the business.

Seems that present thinking is to broaden the criteria to four or more, aligned to the goals, then to take a balanced approach to what the executive commits to achieving in the year ahead.

One leading New Zealand remuneration practitioner advocates Earnings being no more than 40% of the STI reward opportunity, with 3-5 other metrics, adjusting annually in line with business strategic needs and operational targets.

And because organizations are synergetic teams, the concept of an STI pool has considerable support. Funded by formula (say 5-10% of operating profit), the pool allocates incentive reward across the selected executives in some equitable ratio. Clearly it is important that the pool stretch beyond the CEO, but not necessarily to all members of the Senior Management Team; perhaps just to the line executives, with staff positions (e.g. CFO, CIO) being well remunerated by fixed salary. While more complicated, an amalgam of individual and team-pool variable pay seems both acceptable and effective.

As to overall maximum reward, New Zealand practice is mixed but appears far less generous than either Australia or USA. Owners with Chinese backgrounds seem especially lavish to their high performing CEOs. A designed maximum or cap at say 75% of base salary would likely be seen as generous in our market but niggardly elsewhere.

In the constant challenge to recruit and retain talented expertise, the subject of remuneration requires considerable focus and professional input.

Wouldn’t we all love to enjoy “meaningful freedom” like Bill Gates!