Linking Executive Performance & Pay

April 6, 2011

Compensation based on the short term, rear-view mirror is getting outdated.

Executive Performance Overview

Many organizations have tried and failed in their attempt to close the gap between Executive performance and compensation.  In most organizations, Executives’ greatest concerns are top line growth and profitability as these are directly linked to overall compensation packages.  Although shareholders tend to look favorably on these factors as share prices appreciate, this type of compensation package promotes negative short term behavior often resulting in questionable activities or long term organizational capability destruction.  Therefore, it is extremely important to ensure the correct indicators are being measured to accurately reflect the overall value of the organization and performance of the Executives.

Executive Performance – KPI’s & Compensation

Key performance indicators play a crucial role in ensuring a business is strategically aligned with the business goals and achieving desired results.  However, most organizations evaluate Executive performance based heavily on financial key performance indicators such as EBITDA, gross profit, and net income and fail to capture other, but equally important non-financial related aspects of the business.

Many organizations utilize lagging financial indicators such as profit and revenue growth while failing to incorporate forward looking leading indicators into Executive performance evaluation.  Although lagging indicators are a very important aspect of any business and show an Executive’s recent performance, they alone show past results and fail to capture what is required to improve or sustain desired goals & results.  Therefore, it is equally important to include leading KPI indicators to ensure Executives are successfully managing the day to day operations of the business while simultaneously focusing on both future long term growth initiatives and profitability.  To achieve this, indicators must address all areas of the business including financial, customer, internal business processes, and learning and growth to ensure the enterprise if performing in all areas and is strategically positioned for long term sustainably growth.

Executive compensation packages that include reasonable incentives for short term performance and higher incentives for long term performance and sustainable growth truly manifest the characteristics required to promote positive behavior and represent the greatest value creation for shareholders.

Performance should be evaluated on achieving financial and non-financial objectives to ensure all facets of the business are performing.  Other factors, such as retention, cost reduction and control, overall productivity, and strategic alignment with corporate goals are important characteristics that also need to be considered.

With stock options representing the fastest growing segment and accounting for over half of Executive compensation at some of the world’s largest companies, it is imperative that corporate boards of directors determine the most important indicator’s and levels of performance on which to evaluate, rather than following traditional, or outdated models.

Otherwise, any increase in the company’s stock price represents positive performance and rewards the Executive (option owner) without distinguishing between positive or negative performance.

Conclusions

Although Executive performance and compensation are areas that will continue to evolve and be the center of great debate, corporate boards who are able install meaningful key performance indicators, structure Executive compensation to promote long term strategic thinking, and reward above average market performance will create lasting value for shareholders.