Final Round Deadline
Encouraging patient organisations; rebalancing compensation systems to provide incentives for long–term value creation along with short-term performance.
This response specifically focuses on how compensation systems could be rebalanced to provide incentives for long-term value creation along with short term performance. The focus of this rebalancing of compensation systems is specifically for large organisations, government entities and publically listed companies. This response does not specifically seek to outline how measures within these systems are created, but how systems can be tied to the measures once developed.
Employee ‘compensation’, ‘remuneration’ or reward (terms that may be used interchangeably) may be defined as ‘all forms of financial returns and tangible services and benefits employees receive.
This response will outline that aligning compensation for both executives and employees with long term measures could be a step towards a more principled, patient and socially accountable capitalism.
Executive compensation is a topic of debate and conversation at the moment. Compensation systems have been blamed for being integral to the causes of the global financial crisis as they focused employees, specifically in large financial institutions, on short term gains over long term organisational health. There has been movement to build long term measures and deferred payments into executive compensation systems as disincentives to short-termism in executive decision making. The problem remains however that organisations are made up of many employees who are not executives who also make decisions and perform roles that have longer term impact than the performance year they are often measured in. To encourage patient organisations, long term value creation must be incentiveivied in all employees’ not just executives.
One solution to accelerate towards the goal of long term sustainable Capitalism must then be the re-design of remuneration systems that do not accept short term-ism as the driving factor, but rather long-term value creation for all employees not just executives. These re-designed systems cannot however ignore the shareholders desire for short term performance and stock gains. A system or principle that balances the two conflicting demands of long-term value creation and short term performance must be designed as a step on the path towards sustainable long term capitalism.
A solution would be to extend the mechanisms used in redesigned executive compensation systems with all employees. Compensation systems should be re-engineered to be in three parts, base pay, short term variable pay and longer term multiyear payments that are exposed to positive and negative variance. The focus of the longer-term multi-year payments, either in cash or share option schemes and the like, need to be either linked to specific measures within the employees control or to longer term sustainability measures of the company.
It is suggested that employee’s compensation become realigned in three ways;
- Base pay that is large enough to attract the talent required for the organisation.
- Performance based pay that is variable and based on short term organisational goals.
- Multi Year horizon deferred payment linked to specific outcomes within the employee’s control. If this is not possible then the multiyear measures are substituted for organisational sustainability measures based on the long term organisational strategy. This can be way of variable cash or variable share options schemes or similar. These measures and payments must both share a positive and negative effect over time so employees can share in both the up and down side of the long-term impacts of their performance and the organisations health.
It is important that the system is not diluted further than these three major sections as it may be too complicated to see the line of sight between effort and performance if the compensation system becomes too complex.
To understand how this would work in practical application I have outlined two scenarios below;
Example 1; an employee, a University recruiter, who is compensated to deliver both short and long term outcomes;
A University recruiter may be paid a base salary, a variable cash payment for recruiting the correct number (say 50) students to a specific intake. Then have a deferred payment at the completion of that programme; based on how many of those 50 students completed the programme successfully. The final measure would have to be benchmarked so that normal attrition rates etc were built into the final target so the Recruiter could see how their performance in selecting those students affected the overall outcome being the number of students that successfully completed the programme. The recruiter would receive an increased payment if more than benchmarked number of students completed and a reduced payment if the completion number was less than this. This approach would encourage the recruiter not only to recruit the required volume of students but also to incentivise a focus on the quality of the students so that the multiyear payment was achieved.
Example 2; Personal Assistant in a large organisation
When a role has no clear, tangible long term deliverables that would be executed over a multiyear horizon it is suggested that variable long term payments are linked to sustainability measures in line with the long term corporate strategy. For example a PA to an executive would receive a base pay, short term variable targets based on performance in the role and then long term payments linked to organisations sustainability metrics. These metrics could be long term share price in the simplest form, or more granulated targets in line with the organisations long term strategy, such as customer satisfaction metrics, power use reduction targets, or successful implementation and measurement of health and safety initiatives.
When supported by clear communication and line of sight programmes to highlight individual impact to these metrics it would shift focus just from short term performance to a balance of short and long term outcomes. Employees will be forced to think past the normal annual performance cycle and will be more reluctant to sacrifice long term organisational health for short term performance.
To implement such a step change in the way employees were compensated would not be simple but could be hugely beneficial to an organisation over the long term.
Any organisation that was committed to driving out short-termism and utilising compensation system re-design as a mechanism would first need to follow the steps below;
Long term strategic plans would need measures allocated against them so that employees who did not have specific measurable long term impact in their roles would have long term horizon metrics. It would be hoped that this is implicit in the plans already.
An overhaul of the existing compensation and performance management framework would need to be initiated with fundamental decisions such as salary base value positions in the market re-evaluated. The framework would need to allow for multi year performance goals that are not traditionally used outside of the executive suite.
Once a policy and performance management framework are in place a change initiative would need to be implemented to ensure employees understood the framework and that they have ‘line of site’ between effort and performance . Management training and instruction would also be key to ensuring that managers across an organisation are able to coach and mentor their employees to ensure they understand how they would be measured and paid.
All this would need to be supported by a communications strategy that was very clear on why the organisation was moving to a system that encouraged long term organisational heath in balance with short term performance