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January 01, 2000
Aligning Performance and Rewards: It Starts at the Top
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cutive compensation continues to climb. It is not as closely related to business performance as critics would hope.

In 1998, Standard & Poor's stock index rose 26.7 percent, and earnings of the companies in the index fell 1.7 percent. But chief executive compensation increased by 36 percent (including exercised stock options).

Does this lack of alignment really matter since executive compensation is a minor cost for most companies? It does because of its symbolic importance. During that same time period, overall U.S. wages and benefit increased by only 3.5 percent.

The pay gap between executives and the workforce continued to widen; CEOs in this analysis were paid more than 400 times the average blue-collar wage. And incentives for workers are typically tied to results under the mantra of pay for performance.

However, the link between pay and performance is becoming stronger for executives as well. Companies are starting to base executive compensation strictly to performance.

Monsanto's stock option plan, for example, provides that the price executives must pay to exercise an option is set at 150% of the market price at grant and they must pay half of the present value of the option at the time of its grant. This practice clearly aligns executives and other Monsanto shareholders.

Here are some positive executive compensation actions to take:

  • Closely align executive rewards with actual measures of company performance in addition to just the price of common stock, with greater pay variation based on performance.
  • Formally evaluate chief executive performance by the board in relation to established goals in addition to financial measures. For example, strategic goals and how the leader serves as a role model for the general workforce.
  • Provide a total pay mix of less fixed (base) pay and more variable pay (cash and equity) based on performance.
  • Balance short-term and long-term variable pay. Make it necessary to sustain growth and profitability over the long term.
  • Emphasize and increase the rigor in stock option design. Add strategic success measures as features of vesting and the number of options available, especially at the executive level.
  • Stress executive stock ownership to build confidence in the investment community that leaders are stakeholders in the company's future. If reloading and repricing of options must be used to keep critical talent below the executive level, avoid inclusion of executives who have a primary opportunity to influence stock price performance.

Companies that follow this roadmap find that executive pay serves as a model for paying the rest of the workforce. We believe this is the most powerful reason for paying executives based on performance.

This provides the opportunity to align everybody's pay more closely to key business goals. Everyone can be paid according to the same principles; it becomes part of the culture and builds trust and commitment to "we are all in this together."

Executives and senior managers are expected to champion and lead pay changes in support of needed business change, but they must do it by example. Whatever key strategic measures are considered for executive compensation should "cascade" to the workforce.

For example, a financial goal for the CEO can translate into a goal others can attain and that influences financial goals. The same is true of customer goals. Unless executive compensation is linked to workforce goals, it is difficult to make a company's goals credible to its people and gain their acceptance, commitment, and alignment.

Predictions for Great Companies

As executive rewards become more focused on business goals, attention will turn to where it belongs-to the total pay of the entire workforce. This is the pay solution that really counts.

Great companies are dramatically changing how they reward people below the executive level so pay more powerfully serves the enterprise as a tool for communicating business directions and goals.

Despite notorious and exaggerated examples of unreasonable executive compensation, many premier companies such as IBM, GE, and Monsanto have been changing total pay design for their entire workforce to encourage all people to become stakeholders in the business.

For example, IBM has placed all employees throughout the world on performance-based incentives with measures that cascade from those which apply to the leadership team. GE makes sure that organizational performance is a factor in pay management to make the workforce stakeholders in success.

The changes we suggest are likely to accelerate into the new millennium and provide broader-based competitive advantage to enterprises that realize the importance of rewards to their formula for success.

Why change pay? Is there no simpler way to gain workforce alignment? Pay is a "hot" change tool that gets everyone's attention. In business speed counts.

Companies that want to grow and prosper cannot wait for "cold" change tools such as recruitment and training strategies to get the message through to the workforce.

Instead, pay change is the accelerator pedal for change initiatives. It requires a powerful effort to communicate new directions and priorities that are not supported by reward design. This makes pay change essential.

Patricia K. Zingheim and Jay R. Schuster are partners in Schuster-Zingheim and Associates, Inc., pay and rewards consulting firm. They are the authors of a new book, Pay People Right! Breakthrough Reward Strategies to Create Great Companies, and The New Pay: Linking Employee and Organizational Performance. Their Web site is www.paypeopleright.com. Their books are available on Amazon.com.

Pay People Right! and The New Pay

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