Compensation Philosophy

The compensation and organizational development committee plays an essential role in setting the overall tone for the company’s philosophy with respect to rewards and incentives generally and executive compensation in particular.  Among other things, the members of the committee are expected to continuously review and assess the company’s executive compensation philosophy and provide counsel and guidance to the CEO and leaders of the human resources function with respect to alternative approaches to rewarding employees for the work they perform on behalf of the company.
When preparing the statement of the company’s executive compensation philosophy the committee should begin with a description of the primary purposes of the executive compensation program, such as attracting, retaining and rewarding talented leaders who can achieve sustainable and profitable growth for the company’s businesses and maximize the long-term value of the company for its shareholders and other stakeholders.  The statement of philosophy is often broken out into several categories, each of which are considered to be important for recruiting and retaining the best people to lead the organization.  For example, realizing that qualified and experienced leaders are highly sought after it is essential that companies be prepared to offer compensation packages that are competitive, which means that the statement of philosophy should incorporate the following activities:

• Regularly compare the company’s total compensation levels against comparable companies in each of the industries from which the company is likely to draw executive talent, with particular emphasis on salary levels and short and long term incentives, to ensure the ongoing competitiveness of our compensation program
• Measure the competitiveness of compensation levels in the countries and regions where the company operates, and utilize compensation benchmarks from multiple geographic markets for executives with international responsibilities
• Use median (50th percentile) compensation values reported by the company’s comparator group companies as a primary reference for establishing target amounts for each element of compensation, and for maintaining competitive total compensation levels
• Consider factors related to the executive’s potential impact on the company’s results, scope of responsibility and accountability, and reporting structure in determining appropriate compensation levels

It is necessary, but not sufficient, for companies to offer competitive compensation arrangements to their executives.  Compensation plans must also motivate executives to consistently deliver superior performance and this means ensuring that executives have a significant proportion of total annual compensation contingent upon achieving objective measures of financial and operating performance; establishing an appropriate “mix” of compensation elements to ensure an appropriate and balanced focus on short- and long-term results; and preserving a strong and direct relationship between business and individual performance, and the short and long term compensation earned by executives.  Committees should strive to create incentive arrangement that provide executives with opportunities to achieve compensation levels comparable with the highest earners among their peers at other companies; however, incentives should be tailored so that they are aligned with the company’s long-term strategic objectives and not just winning compensation battles with competitors.
Finally, the compensation package should be built in a way that ensure that executives are properly engaged with the pursuit and achievement of the company’s long-term strategic goals and meeting the expectations of the company’s stakeholders.  Engagement provides a foundation for building a deep and committed relationship between the executive and the company and makes the executive a stronger ambassador of the company to both internal and external stakeholders.  In order to achieve engagement, the company’s executive compensation philosophy must include linking a material portion of executive compensation to measures of business performance for which the executive has direct line of sight and accountability; ensuring that the company’s compensation programs and practices encourage appropriate risk taking and discourage inappropriate risk taking; and ensuring that senior executives meaningfully share the risks and rewards of ownership with the company’s shareholders by basing a portion of their total compensation on share price performance.  While compensation arrangements have traditionally emphasized achievement of financial goals, mounting pressure from institutional investors and other stakeholders has driven companies include sustainability issues in their executive compensation philosophies and explicitly provide that sustainability performance and innovation will be tracked and that a significant element of executive rewards will be based on demonstrable success in those areas.
This article is adapted from material in Sustainability and Corporate Governance: A Handbook for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project and can be downloaded here.
Alan Gutterman is the Founding Director of the Sustainable Entrepreneurship Project, which engages in and promotes research, education and training activities relating to entrepreneurial ventures launched with the aspiration to create sustainable enterprises that achieve significant growth in scale and value creation through the development of innovative products or services which form the basis for a successful international business.  Visit the Project’s Library of Resources for Sustainable Entrepreneurs to download handbooks, guides, articles and other materials relating to sustainable entrepreneurship and keep up with the Project’s activities by following Alan on LinkedIn, Twitter and Facebook.