Trends in Executive Compensation
Trends in Executive Compensation
Does this sound familiar? "Our executive compensation philosophy is to attract, retain, and motivate top talent."
This is the most common phrase seen in executive compensation philosophy statements and hasn’t changed since the dawn of formal executive compensation programs in the 1970s. But, as business owners, shareholders, and boards strive to secure executives who can drive the company’s success, it’s essential to understand the trends in executive compensation and how to motivate and retain these leaders.
What has changed, however, is that executive compensation continues to evolve and become more of a driver tied to meeting overall company objectives and individual contributions to those goals.
Pay for Performance
While base salary continues to be an integral component, increases in executive pay are primarily in the form of incentives – both annual bonuses and long-term incentives, making pay for performance the name of the game for most businesses, whether a public or private company.
Entirely discretionary programs have mostly gone by the wayside as shareholders and investors weigh in on company and executive performance expectations. Many programs – directly in the case of long-term incentives and indirectly in the case of bonuses – are meant to reward executives in conjunction with the size of shareholder returns.
ESG and DEI&B in Executive Compensation
As businesses look to become socially conscious and leaders in the communities where they operate, there has also been growth in the use of Environmental, Social, and Governance (ESG) and Diversity, Equity, Inclusion & Belonging (DEI&B) metrics in bonus programs. Doing so allows boards to hold management responsible for broader objectives beyond just the bottom line.
Interest in long-term incentive design is especially high in 2023 and continues to gain popularity. Both public and private companies have a broad array of long-term incentive vehicles to choose from, including equity (stock options, restricted stock awards), profit interests, synthetic equity (e.g., stock appreciation rights), restricted stock units, and performance cash plans. In addition to providing competitive award values, it’s essential to consider the differences in structure, tax treatment, accounting, and the dilutive effect when implementing long-term incentives.
Trends in plan design vary by company type, whether a public or private company, including private equity funded, a family business, or other.
Public Company Trends:
Public companies must comply with expectations from shareholder advisory firms who influence voting on executive compensation. This leads to a high commonality in long-term plan design among public companies, balancing time and performance-based features. The use of stock options has declined, and the instruments “du jour” are time and performance-based Restricted Stock Units or Restricted Shares. Public companies are subject to pay and performance disclosures meant to provide guardrails around both the form and amount of compensation.
Private Company Trends:
Among private companies, there is more customization opportunity based on a company’s ownership structure, industry, growth trajectory, maturity, exit strategy, and competitive environment. In a high-growth or private equity-owned company, the plan is likely based on appreciation in Enterprise Value or an expected return on investment. For example, private equity-owned companies historically awarded stock options or profits interests (where the value to the executive is appreciation only). Private equity firms have recently introduced performance units, adding a time-based vesting component to encourage management retention. In this case, value to the executive is fully realized only upon the sale of the company. These plans tend to be “high risk and high reward” and work best where there is a clear path for executives to achieve objectives and obtain rewards.
A mature, family-owned company with no intention to sell may implement a long-term cash plan based on the achievement of financial metrics. The awards may vest in three to five years or upon retirement or sale of the company. These plans tend to generate less value for the executive than an equity or synthetic equity plan and include caps on payouts.Though family or founder-owned companies have shied away from awarding equity in the past, those with aggressive growth objectives are now considering synthetic equity programs which attract and retain the talent needed to achieve objectives. These programs mimic growth in company value but pay awards in cash.
Increasingly, private companies seek to attract executives externally, including talent from public companies. In the last decade, public company practices have influenced the evolution of private company executive compensation plans.However, private companies can break from the mold and create a plan closely aligned with business strategy and executive talent needs, with greater flexibility than public companies.
Plan Design Should Consider:
- Establishing stretch but realistic Key Performance Indicators (KPIs) of the business and rewarding executives to achieve those metrics;
- Aligning executive interests with those of shareholders and owners;
- Enhancing a company’s ability to attract and retain top talent;
- Providing a fully competitive compensation program considering total rewards;
- Sharing increased company value with executives; and
- Emphasizing understandability and clearly communicating plan design and potential value.
A robust plan design is essential to establish a successful executive compensation program, but the documentation, communication, and administration of executive compensation plans are equally important.
In sum, today's competitive business and talent landscape has no “silver bullet,” off-the-shelf executive compensation plan. The most effective plans are closely aligned with business strategy, which is different for every company, and have carefully considered all key factors during the design process.
As the importance of getting executive compensation right grows and also becomes more complex, connect with our workforce strategists and HR Consultants for customized solutions that ensure your programs are set up to attract and retain your top talent.
Ready to get creative with your business strategy? Read Combating Inflation with a Holistic Total Rewards Strategy.