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Changes to executive pay packages during the COVID-19 pandemic have been swift, revealing stark differences in how boards approach compensation for public and privately held companies. Many executives at public companies reliant on annual and long-term incentives (LTIs) are facing significant pay cuts in the wake of dwindling profits with more economic uncertainty ahead. For stable or growing privately held companies, this presents a buying opportunity to attract and capitalize on executive talent with the right compensation strategy.

Executive Pay Practices

Media coverage based on filings and disclosures required for public companies along with say on pay votes ensures most people are familiar with executive pay practices at public companies. This publicity and the large role played by proxy advisors has resulted in a standardization of executive compensation in public companies as no one seems to want to stand out. To play it safe, public companies typically target the market median with stock performance the largest component of pay results.

Photo courtesy of Pixabay

Private companies, on the other hand, without the limitations of public exposure can implement more creative pay programs that are crafted to each organization’s unique circumstances. With stock performance a non-factor, other innovative measures including non-financial metrics can play a more meaningful role.

Although pay practices for both public and private companies vary significantly depending upon the industry and type of ownership, all are designed to attract and retain top-notch talent. For private companies, this means making pay sufficient for the quality of executive they are seeking and aligned with the values and goals the organization has established.

However, in our current, challenging business climate, private companies have the distinct advantage of being more flexible, agile, and inclusive than their publicly traded counterparts. In that sense, it may be a golden opportunity to seek where the grass may be greener to upgrade or expand executive ranks.

The Elements of Executive Pay

Public company executive compensation is comprised of three components: base salary, annual or short-term incentives (STIs) and long-term incentives (LTIs). In public companies, incentives dominate executive pay, including annual incentives and long-term, equity-based incentives. Further, in public companies LTIs are the largest component of compensation.

In contrast, private company pay centers on cash compensation, emphasizing base salary and annual incentives. Cash pay is often positioned above the market median, with low or no LTI opportunity. However, this trend is changing as more private companies offer more incentive-based compensation as reported in the Compensation Advisory Board (CAP) and WorldatWork 2019 survey of Incentive Pay Practices.

Executive Pay Components

  Base Salary Annual or Short-Term Incentives Long-Term Incentives
Public Companies 1) 20% of compensation package
2) Some are temporarily reducing base salaries
1) Financial incentives tied to key performance metrics
2) Sustainable Impact measures: Environmental, social and governance
3) Seeing reductions of 25% to 50% of the current plan target opportunity
1) Some adjusting targets on a year-by-year approach
2) Others extending the performance period
Private Companies 1) Stressed
2) One-third to half of compensation
1) Financial measures: profitability and revenue
2) Individual performance common
3) Threshold payment about 50%; maximum payout is 150% to 200% of target opportunity
1) 60% offer LTIs
2) Cash-based plans most common
3) Phantom stock, or real stock vehicles added by minority of companies

Add LTIs to the Pay Mix

Long-term incentives are fast becoming a growing element of executive compensation for private companies. They are essential to attract talent in competition with public companies where LTIs are common. In addition, LTIs play a major role in company retention strategies and to motivate executives to achieve long-term objectives.

Photo courtesy of Pixabay

For owners at private companies, they must thoughtfully consider if and how they are willing to share ownership in the enterprise with other executives. In addition, they should consider succession plans and future liquidation or merger opportunities depending on their long-term plans for the business.

A typical sharing percentage range is between 5% -10%. Phantom stock is another vehicle often used, although these programs require sophisticated valuing studies and strong communications support. A final option is a long-term cash plan. This requires solid financial planning and transparency of key financials.

Benchmark for Success

Executive pay has come under increased scrutiny in the current business climate. New attitudes about work and pay practices are being shaped by the pandemic, as well as social and cultural trends in an election year like no other. Executives seeking to make meaningful contributions may find even greater opportunity at private companies embracing innovative strategies and pay practices. Private companies recruiting new talent can cast a wider net and utilize benchmarks for non-traditional sources and their market competitors.

Photo courtesy of Pixabay

Still, benchmarking in a rapidly changing business environment can be challenging, making salary projections more obscure. Regardless, the quality of survey data obtained for an executive search must meet high standards. Survey sources should be carefully examined to ensure data cuts are available based on industry and size, which are closely related to the level of executive compensation.

Summary

With less public scrutiny and fewer regulatory hurdles, private companies have more freedom to make proposed changes in creative ways that balance stakeholder interests, improve employee morale and boost the bottom line. Executives at public companies may be ready for a change if an opportunity promises a promotion or broader role or one with more autonomy and more responsibility.

Yes, pay will certainly be an important piece of the equation. However, at a time when job losses in the top ranks may be considerable, enterprising private companies should view this as a recruiting opportunity to build on for the future.

Contact Us

For help or information on this topic, you can email me at nlappley@lappley.com or call (847) 921-2812.

When we look back, 2020 will long be remembered as a year of massive change for business and industry on a scale not seen before.

The COVID-19 pandemic has plunged our economy into a global recession and put health and wellness at the center of workplace conversations. Worldwide protests supporting the #BlackLivesMatter movement have joined #MeToo voices urging meaningful community action on discrimination, pay equity, and inclusion.

In response, organizations are making significant changes to their business models and accelerating the adoption of Environmental, Social and Governess (ESG) criteria to guide business investment and decision-making. They recognize that their organizations’ stakeholders are motivated by more than a goal for increased revenues and profits; other success metrics include environmental, social responsibility, gender, and racial diversity measures to track progress on social and economic purpose. Some are calling this new integrated approach to corporate governance stakeholder capitalism.

In tandem with these changes, proactive CEOs and HR professionals are taking a step back to reassess their compensation programs, so they align with a more purpose-driven business model. This is an opportunity to transform massive challenges into meaningful change, but it will require a thoughtful and strategic compensation approach that looks at the following:

1) Assess critical job skills. Quite likely, as the result of an updated business model, critical skill jobs have changed. They should be identified and monitored for pay competitiveness. These employees are most susceptible to being recruited away.

For instance, purchasing professionals are dealing with disruptions in their supply chains, especially in manufacturing. Sourcing from India and China has become problematic during the pandemic. Employees that can fill supply chain gaps are highly valued and in great demand. Employers may need to prioritize their investments in these job skills even when resources are scarce.

2) Revisit your compensation strategy. This flows from the company’s purpose and business strategy and is part of the organization’s overall HR strategy. To the extent that your business model has changed, compensation strategy must also follow the organization’s purpose or why it exists. A recent Compensation Alert here takes you through the elements of establishing your strategy. A critical part of your updated strategy will be to reestablish your benchmark of competitive and comparable organizations, update your current competitiveness levels and determine your targeted level of competitiveness.

3) Take a fresh look at pay equity. Many employers have implemented pay equity analyses to identify whether they have gender or race-based compensation gaps. They have done this to promote fairness, retain talent, and mitigate risk. If you have not done a pay equity analysis already, you should begin the effort soon. If you have, dig deep into the data to determine what is driving pay disparity: the actions of certain managers or decision-makers; out-of-date policies or business practices; or unconscious biases within a division or department. You can learn more about Pay Equity and The Rules of Engagement here.

4) Review base salary and incentive plans. Many companies have taken salary actions in the wake of the COVID-19 health crisis. These include pay cuts, cancelled salary increases or freezes, delayed or deferred annual salary increases, and adjusted planned average salary increases. In addition, organizations have suspended promotional increases or added additional pay for essential work (often called hazard or hero pay), while others have reduced or suspended benefit programs. As the economy improves, business leaders must determine when and under what conditions salary actions taken during the health crisis will be lifted or withdrawn.

It is too early to forecast levels of average merit increases for 2021. It is more likely, however, that more companies will not be giving salary increases next year. Even more, this will vary by industry and region, so it is prudent to develop a good idea of what your competitors will be targeting.

Incentive plans have also taken a hit from the pandemic, as organizations have modified their short-term and annual incentive programs by reducing opportunity, deferring or delaying payments, and adjusting performance targets. Changes to long-term plans have been less prevalent. Consider the following actions:

  • Short-term plans: As you plan for the second half of the year and revenue and profit expectations crystalize, consider: increasing the use of management discretion in determining 2020 incentive/bonuses; changing performance measures consistent with repurposing of the company; and lowering performance targets, maximums and thresholds. Additionally, revisit base payouts on second half performance against second half goals.
  • Long-term plans: Take no actions for the next several months. Consider adjusting performance targets if goals become unattainable.

5) Do not overlook your sales force. The COVID-19 pandemic had a great effect on sales organizations. Orders for commercial and industrial goods were curtailed. Falling orders meant less revenue for sellers for sales compensation credit. Our work with clients indicates that most companies have implemented pay protection methods to replace some or all lost sales incentives for sellers. The most popular methods include pay guarantees, quota reductions and formula changes.

It is time to reset for the balance of the year. Sellers need to be reengaged to reactivate suspended opportunities and find new revenue. A good time to start fresh is July 1st, the start of the last half of the fiscal year for many organizations. But at the same time, discontinue pay protection programs. The sooner you are beyond pay protection programs the better. Consider the following actions to fast-track sales revenue:

  1. Redo quotas: Continued uncertainty will make it difficult to project expected revenue for the second half of the year. However, take into account new avenues for revenue based on your adapted business model as well as revenue purchasing customer patterns. Develop stretch goals.
  2. Review payout formulas: Thresholds, incentive rates, accelerators and caps should be reviewed.
  3. Jump start incentives: As an add on, use a combination of contests and spiffs to add excitement, and motivation. Provide both cash and non-cash awards. Keep the jump start short – a maximum of three months.

In Conclusion

Uncertainty and change will be the hallmarks for organizations during the remainder of 2020 and into 2021. Short of a crystal ball, prudent planning to address the workplace issues of our time is your best bet to make your culture stronger and better equipped for future growth.

Despite current economic hardships, visionary business leaders who understand where and how to prioritize investments in talent will seize the opportunity to recruit the best and the brightest for the road ahead.

Contact Us

To discuss how to adjust your organization’s compensation strategy and develop more meaningful benchmarks and metrics to make your workplace stronger, please contact Neil Lappley at (847) 921-2812 or nlappley@lappleiy.com.

Sometimes great advice comes from our peers and respected colleagues. This is why networking, panel discussions and webinars are such powerful business education tools.

With that in mind, this issue of Compensation Alert shares expert insights from a diverse group of human resource (HR), management consulting, compensation and employee retention leaders. We asked them for feedback on three key questions impacting hiring and compensation management decisions in 2020. Our experts include:

  • David Gilmartin, managing director at Patina Solutions, a management consulting firm that partners with organizations to fill a key expertise or resource gap.
  • Jeff Kortes, an employee retention consultant, author and speaker. Jeff is founder of Human Asset Management.
  • Aaron Schneider, managing director of the Petenwell Group, an executive search and employee retention firm.
  • Rena Somersan, president of the Milwaukee Area Compensation Association (MACA). Rena also is the Newport Group’s managing principal, compensation consulting services.

Of course, HR compensation consultant Neil Lappley, founder of Lappley & Associates and publisher of this newsletter, also weighs in.

Here are Your Three Questions and Answers From our Top Experts:

1) What do you think will happen with wages, salaries and benefits this year?

Salaries will continue to increase; part of that is driven by what everyone is calling the “labor shortage.” Benefits will remain the same. Aaron Schneider

Wages and benefits will (increase) at a higher rate; lowest-worker wages will finally start to push the next tier of worker wages up. Middle-level managers will see wages go up at a rate lower than the lowest tier because (they) tend not to leave and (so) are subject to the “salary pool budget.” Jeff Kortes

Photo courtesy Pixabay

Wages will remain flat this year. With the state (of Wisconsin) not making changes to minimum wage, that alleviates the short-term risk.

Still, (there is) concern changes (will be) made for 2021 and beyond or at the federal level. David Gilmartin

Our market intelligence suggests that 2020 wage growth for production, professional (non-management), management, and executive job classifications will remain largely unchanged from the prior year, hovering between 2.8% and 2.9%. While we do not anticipate sweeping changes in benefit plan offerings for 2020, employers are modifying their benefit plans to entice younger workers. (Offerings include) tuition forgiveness, flexible schedules, and richer parental leaves of absence. Rena Somersan

Median salary increases will be flat at median 3.0% and average at 3.2%. Assuming the Consumer Price Index increases by 2.3% as projected by the International Monetary Fund, real salary increases will be .7%, the lowest level in 40 years. Neil Lappley

2) What are the biggest HR challenges facing your clients? What have you been hearing from them?

Recruiting and retention (are) the biggest challenge(s) and will be for the next decade at least. My manufacturing clients are still afraid to raise prices, but when they have gotten past that they have been making (prices) stick by telling clients they (can’t) keep talent if they are not competitive with compensation. When the argument is presented in this way, customers accept the increases. Jeff Kortes

No question the two biggest challenges facing management are retention and recruiting. Companies are expanding their sources for new workers and are paying more attention to taking care of current employees. For HR and compensation professionals, emphasis is being placed on pay equity and pay transparency. Neil Lappley

Photo courtesy Pixabay

Employee retention and hiring are my clients’ biggest challenges. The availability of skilled laborers is a significant risk in Wisconsin and beyond, especially with our strong manufacturing base. There is also concern for finding leadership and technology skilled resources. One example: Milwaukee Tool needs to find almost 800 (new) employees as they continue to expand in SE Wisconsin. David Gilmartin

Our clients and members of MACA are concerned about executive talent flight. The job market is hot for skilled executives who possess the managerial fortitude to lead organizations through major transformations in today’s increasingly competitive global economy. Rena Somersan

The pressure is on to review systems and processes. Many HR managers are under increased pressure to increase benefits, find candidates for job openings, and (improve) employee engagement. These managers are noticing that some of the same systems that worked for the last several years are changing. Aaron Schneider

3) What would you advise your clients – especially small and mid-sized businesses – who are having trouble hiring and retaining top talent in the current business climate?

As companies struggle to differentiate rewards and recognize excellent employee performance, they are increasingly turning to incentive compensation, both in number of programs and numbers of eligible participants. At the same time, employers are relying on gig workers to fill employment gaps in the tight labor market.

In addition, to capture and retain talent, employers are personalizing employee benefits – not necessarily high-cost perks – that align with their culture, offer greater flexibility and work-life balance. Neil Lappley

My advice it to take advantage of firms like (ours) who (can provide) experienced professionals who are willing to work in interim and project-based roles with clients. Businesses need to look beyond the Wisconsin state border; (Patina Solutions) has access to those resources and the ability to expedite the hiring process for our clients. David Gilmartin

Increasingly, executives at SMBs are being hired by larger companies. These larger companies likely have long-term incentive (LTI) programs in place to attract, retain, and reward executives for their contributions to the business. LTI programs provide actual or pseudo “ownership” in the firm and typically comprise a large portion of the executive’s total direct compensation package.

Photo courtesy Pixabay

To maintain a competitive edge, SMBs should determine whether their executive compensation programs provide a long-term incentive opportunity for key executives. The LTI opportunity should be aligned with the company’s strategic plan and future growth goals, and it should provide monetary rewards commensurate with performance and appropriate levels of risk taking. Even if SMBs cannot provide “ownership” in the traditional sense (i.e., equity), several cash-based program types might be considered. Rena Somersan

Hire where you are at. Meaning, in small and mid-sized organizations, it is important to hire people that fit your current organization, but maybe can take you where you’re going. (This also means not hiring) someone outside of your current capabilities. If you are focused on the ideal candidate and not getting jobs filled, shift to hiring candidates that fit the culture and be ready to train them up on the needed skills. Aaron Schneider

Focus on retention. In my case, I tell them to pay competitively and “Give their Employees C.R.A.P.”  (Caring, Respect, Appreciation, and Praise). Develop a strategy to retain people (versus) trying to recruit people. Jeff Kortes

Do you have more questions about where wages, compensation and benefits are heading in the current economic climate? Or would you like to connect with any of our Q&A contributors? If so, please contact Neil Lappley at (847) 921-2812 or nlappley@lappley.com.

Identifying the right talent for your organization’s long-term success is a business imperative. To tap into this talent pool, many companies invest in High Potential Employee (HIPO) compensation programs to develop and retain their most promising future leaders. Researchers from MIT and Harvard have found that companies can consistently identify 3-5% of their workforce as HIPOs.

High potential employee compensation programs typically share these priorities:

  • Building a pipeline of talent to fill future company leadership positions,
  • Expanding HIPO skills with new growth opportunities and experiences, and
  • Rewarding high potentials for their development and accomplishments.

As these priorities make clear, high-potential employees require much more than higher compensation to succeed in the workplace. Training and development are equally valued by high potentials. Likewise, employers who cultivate high potentials by creating structured learning environments that also support their business strategies build competitive advantage.

Photo courtesy of Pixabay

Still, at the same time organizations are mentoring and coaching their high potentials, recruiters have your top performers squarely in their sights for their own critical positions. If they choose to leave, these ambitious and motivated employees are difficult and costly to replace. Not only do companies lose their investment in training and development for HIPOs to another employer, they also incur costs to recruit, hire, onboard and train a new employee at many times more than base compensation.

Turnover Takes a Toll

According to the 2019 Mercer Turnover Survey, U.S. companies had an average turnover rate of 22%. This turnover stat reflects s 15% voluntary, 6% involuntary, and 1% retirement rate. Although employers have little input when their employees leave for personal reasons or to pursue an entirely new career, they do have control over what they pay them and how they support growth opportunities.

Employees surveyed by Mercer gave the following reasons for their decision to leave:

To combat turnover and prevent employees from leaving, Mercer reports the two most prevalent employer practices are continuous compensation reviews and regularly looking at engagement.

Rethinking Retention Strategies

Many companies have programs in place to reduce turnover, especially for their top performers. But too often these programs rely exclusively on traditional compensation models designed to Attract, Retain and Motivate (ARM) employees. This plain vanilla approach may not be enough for future leaders and high potentials.

Instead, more businesses are rethinking their HIPO compensation programs to favor engagement and alignment with key strategic goals. These programs reward and promote employees who exhibit the desired behaviors and serve as role models for others. In addition, they include robust measures that address current performance, future potential and talent fit for the organization’s strategic direction and cultural values.

Many of the elements of a HIPO compensation strategy are like your company’s overall compensation approach. However, reciprocating your HIPO employees’ ambitions with greater opportunities for training and advancement helps build value for your firm.

Here are the key planning considerations:

1. Conduct a Competitive Compensation Analysis

For each participant in the high-potential program, conduct a compensation competitiveness review. First compare current compensation to the market for the participant’s current role. Then compare current pay to potential next positions for the participant.

Analysis should include base salary, recent salary increases, bonus/incentive opportunity and history of earnings, total cash compensation and, if currently or potentially eligible, long-term incentive and total compensation. The result of the analysis will highlight the gaps between current compensation, market and likely next positions.

2. Determine Compensation Program Elements

Not surprisingly, pay often determines whether high potentials either leave or stay at your organization. Here are four key areas to consider when putting together your compensation program:

  • Promotions – Promotions typically target an average of 8.5% for most organizations. The more appropriate target for HIPOs should average 12% to 16%, a 50% to 100% increase over current practice.
  • Base salary increases – Salary increases for 2020 for most companies are predicted to average 3.2%. According to PayScale, retention raises are the second highest reason for granting a salary increase. Therefore, for high potentials increase your 2020 salary increase budget from 6.5% to 13.0%, an increase between 100% and 200%. Consider developing a separate salary increase budget for high potentials.
  • Incentive/bonus opportunity – The incentive/bonus opportunity should be increased from 50% to 100%. If the high-potential employee is not currently eligible for participation in an incentive/bonus program, consider establishing a separate plan.
  • Long-term incentives – If the high potential is not currently eligible and a potential new position does include participation, consider including at an appropriate level during the current role.

3. Prepare Your High-Potential Compensation Strategy

Develop a compensation strategy that is unique for each high-potential employee. For most employers this means platforming from their current organization-wide compensation strategy. Most likely this will mean that competitiveness targets will be greater.

For instance, if the corporate targets for base salary and total cash (base plus incentive/bonus) are, respectively, median and 60th percentile, targets for high potentials might be 75th percentile for base and 85th percentile for total cash.

Next, for each high-potential program participant, select one or several options from a combination of promotions, salary increases, incentive/bonus opportunity and, if appropriate long-term incentive participation.

4. Help High Potentials Learn to Lead

From rapidly changing technology developments to managing multi-generational workers, the challenges facing high potentials require specialized problem solving, communication and people skills to bridge the gap between top executives and the front line. You may want to customize your training opportunities to include different elements for emerging and senior leaders. Development programs should build on current skills while strengthening areas for improvement.

High potentials being groomed for senior positions may move quickly between managerial and operational roles to learn other parts of the organization. Their performance feedback should be frequent and consider time in position and ability to make an immediate impact. If assigned to special projects, performance evaluation should include both leadership of the group and individual contributions. Group project quality, timeliness and results all need to be measured.

A variety of training methods ranging from individual coaching to seminars and workshops will help your high potentials make the transition from being an individual contributor to team manager and ultimately senior executive. On-demand resources through online learning and email communications will reinforce the new skills they have acquired as they put their new knowledge into practice.

5. Don’t Forget Performance Management

All too often, managers focused on their day-to-day responsibilities will lean on high performers to carry out their primary responsibilities while neglecting their role as mentor and coach. After all, high potentials are talented, energetic and highly productive contributors. Include a component in your compensation strategy that ensures managers of high potentials offer the guiding experiences so essential to their development.

Summary

High-performance employees are catalysts in the workplace, inspiring others to work harder and more effectively. Your investment in these top performers will have a ripple effect, setting a great example for their teams and raising the bar on performance for colleagues.

Contact Us

If you have questions about how to develop and reward your high potential employees or on other compensation topics, please contact Neil Lappley at (847) 921-2812 or nlappley@lappley.com. In addition, please share or pass this article along to anyone you think may find it of interest.