How To Motivate Execs: Executive Compensation That Sticks

Executives set the direction for the company, influencing culture, productivity, profit, and results. So, it stands to reason that attracting and retaining top talent for these roles is a critical component of a successful business.

You need to have a compelling executive compensation plan that incentivises effectively and rewards fairly and competitively. 

This goes beyond the important question of how much they are paid, to consider the individual monetary and non-monetary components. It is particularly important to consider how each component is intended to incentivise the behaviours and outcomes needed for business success. It’s also important to consider how it connects and drives the business strategy in order to demonstrate a clear link between CEO pay and an organisation’s overall performance. 

How can you ensure you have the right executive remuneration plan in place?

In this blog, we’ll look at the critical components of executive compensation and how you can put together one that works.

Four Key Components of Executive Compensation

Generally, an executive salary package will contain more components than those of more junior employees. In fact, most executive pay schemes comprise four parts that contribute in varying amounts to the overall package. 

These are:

Base Pay – The portion of remuneration that your executives take home as their annual salary. This will typically be influenced by the complexity of the role, size and complexity of the business, market trends, as well as other individual factors.

Short-Term Annual Bonus (STIP) – Designed to be an incentive to meet performance KPIs in one financial year, the annual bonus may be calculated based on company or individual performance metrics, or a combination of the two. It is not uncommon to see a heavier weighting on company performance for senior executives, whereas more junior employees may have a stronger weighting on individual performance metrics. This is because senior executives typically have a greater individual influence on the overall success of a business than a more junior employee.

Long-Term Bonus (LTIP) – Long-Term Bonuses are often called Long-Term Incentive Plans (LTIPs), which is a generic term to cover a range of different designs and structures. LTIPs are calculated using performance measures over more than one financial year and can be cash, share awards, or a combination of the two. Long-term bonuses are important to counterbalance the longer-term needs of a business, with short-term success rewarded via the annual bonus. This is important because executives are typically expected to make decisions that impact over a longer time period than one year, and sometimes these decisions might be at the expense of short term profit, which could impact the annual bonus (STIP).

Benefits – Benefits refer to all the monetary and non-monetary components that make a role more attractive. At an executive level, these might typically include a company vehicle and enhanced provisions in the monetary benefits such as healthcare and life cover. The non-monetary benefits would typically mirror those available to other employees.

Together, these four components combine to create a total remuneration package for the individual executives in your organisation.

Designing a Great Executive Compensation Plan

Every CEO is different, so ideally, an executive compensation plan needs to be developed with that in mind. 

For example, the CEO of a start-up might be more willing to take risks with their pay, and might be able to earn more through the increased value of the stock, than the CEO of a more established company. Therefore, the proportion of LTIP and stock options would enable the base pay to be lower.

While all four key elements outlined above will be relevant, you should tailor what you include in those four elements to the individual. 

Here are five key things to remember:

Money in the Hand is Important

While big executive bonuses regularly hit the headlines, most people, including executives, would actually prefer to have money in their hand than the promise of a bonus in the future. 

A PWC study found that over half of CEOs are risk averse and would rather have fixed pay than a bonus. A bonus would create a higher take-home value but is also viewed as a higher risk. The requirement to wait for bonuses also gave them a lower perceived value. 

This is sometimes referred to as the risk-reward balance, and getting this balance right is key to ensuring the base and bonus are set correctly.

However, bonuses remain a critical part of the package, as they are the most effective affordability lever for businesses to apply.  Base pay is a fixed cost, with a range of additional on-costs, and is paid whether the business performs or not.  Whereas a bonus is variable and discretionary, has fewer costs, and, when designed correctly, is only payable when the business meets its performance targets and therefore has money to fund the payment. 

Keep it Simple

A pay package that is too complicated can be off-putting even at senior levels. Most executives would choose a clear pay package over an ambiguous one, even if the latter was worth more.

My rule of thumb is, if you can’t explain the design methodology to someone in 30 seconds and without the aid of detailed documents, it is too complicated. 

The exact calculation might need a document, but the design principles should be easy to explain.

Ensure you have robust governance

Governance is critical not only for internal fairness but for external compliance requirements.

The UK Corporate Governance Code contains an entire section dedicated to remuneration, setting out a range of requirements for the fair and consistent governance of executive pay and required or recommended governance processes such as a Remuneration Committee. 

It is important to familiarise yourself with these to ensure that you are compliant, especially if your company falls within this Governance Code.  Even if you are not legally required to comply with the Code, it is good practice to introduce similar internal mechanisms in order to manage pay decisions and pay settings at an executive level.  There may be additional governance codes to consider, such as the FCA, depending on your sector.

Be aware of internal relativities

According to the CIPD, in 2019, the typical FTSE 100 CEO earned 73 times more than the average (median) FTSE 100 worker and 119 times more than the average (median) UK worker. The scrutiny of this gap, known as the CEO Pay Ratio is increasing, with all UK companies with over 250 employees required to include their CEO Pay Ratio in their annual report. 

Be aware of external market practice

In a competitive job market, it’s important to know what your competitors are doing and to make sure you are paying fairly. Like anybody, executives want to feel that they are being paid fairly within their organisation. Unsurprisingly, they also want to feel that they are paid fairly in comparison to their peers in other organisations. 

Robust pay benchmarking is essential when setting executive remuneration. This involves not only looking at a market rate for a role (using the right surveys or data sources) but also taking individual skill and experience into account.

Create an Executive Pay Structure That Works

Executive pay can be a challenging area to deal with. From establishing the most appropriate data source to establishing the right blend of long-term and short term incentives and designing schemes that drive the right behaviours, the reward expertise needed for this population is more nuanced than for the rest of the employee population.

If you are looking to create or revamp your executive-level pay structure, then, as an experienced remuneration consultant, I can work through your requirements with you. We’ll typically start with a thorough analysis of your existing executive pay structures and how each component compares to the market. Then we’ll discuss best practices and put together a draft structure.

I provide clear reports ready to go to the Board and to be discussed in meetings or presentations. Plus, I can also work directly with your CEO, CFO or Executive Team if required.

Get in touch to arrange a consultation today.