As scrutiny around the income inequality gap has increased, so too has the debate surrounding executive pay, especially in the corporate world. Americans are clamoring for organizations across the country to be more transparent and equitable with their executive pay levels.
Executive compensation is under fire because these executives are getting paid more, for longer amounts of time than ever. In this article, we’ll cover the circumstances surrounding executive compensation. How high levels of compensation translate into company performance. And, what your organization can do to improve your executive compensation policy.
The Rise of Executive Pay
Records of CEO pay data, over the last 50 years, have produced startling results. The average CEO tenure at S&P 500 companies has increased over the over the past decade. According to Equilar, the average CEO tenure in 2014 was 7.4 years, compared to 6.6 years on average in 2005.
Executive compensation is on an even more meteoric rise. In 1965 the average CEO earned 20 times the average worker, per The Seattle Times. Now, CEOs of S&P companies make 335 times the pay of their average employees.
So, the average CEO, in 2017, is staying longer with the same company and making more during that time. But do these exorbitant salaries equate to business success? Recent research would say no. Two studies in the past three years have found a negative correlation between CEO compensation and a company’s performance.
In a 2014 study found that “The more CEOs are paid, the worse the firm does over the next three years, as far as stock performance and even accounting performance.” Then just last year, a new study by research firm MCSI discovered similar results.
This newer study found no evidence to show a link between CEO pay and long-term company performance. One-hundred dollars invested in corporations with top-paid CEOs would have grown to $265 over the study’s 10-year window. On the other hand, the same $100 invested in businesses with the lowest-paid CEOs would have increased to $367.
Structuring Executive Compensation
So, executive pay is rising, despite there being little evidence indicating it has benefited organizational performance. Still, there are many ways your company can structure its executive compensation policy align employee and company performance better. Here are four changes your organization can make to its compensation structure to build this improved alignment.
Change Bonuses
On average, according to Harvard Business Review, CEOs receive 50 percent of their pay base in bonuses. And these bonuses are often both too large and tied to the wrong objectives. In fact, the new CEO of Deutsche Bank, John Cryan, said that he had no idea why he was offered a contract with a bonus in it. Cryan said, “I promise you I will not work any harder or any less hard in any year because someone is going to pay me less or more.”
Another troubling bonus trend is paying out bonuses for executives merely doing their job. For example, the CEO of Cheniere Energy received a bonus for completing the financing on a natural-gas terminal. But if the terminal is profitable, the CEO should be rewarded via their holdings of stock. And if it isn’t profitable, then why pay him or her additional money?
Change Pay for Performance
Essentially what Cryan is arguing against are customized performance-based bonuses. These bonuses, per Fortune, are flawed because they incentivize CEOs to focus on short-term goals that are either too subjective or can be easily manipulated.
These short-term goals can result in outcomes that are less than ideal for your organization as a whole. If you want more sales, your CEO will just cut prices. If increased cash flow is the goal, they hold back investment. According to the Harvard Business Review, pay-for-performance doesn’t work for executive roles.
Per HBR, substantial performance-related incentives work best for routine tasks. When the function is not standard and requires creativity, though, these bonuses can be detrimental. Research from Duke University found that variable pay can hurt performance, for people working on creative tasks.
Adjust Your Peer Group
One of the most significant issues resulting in exorbitant executive salaries is the idea of a peer group. The beginning of almost any executive pay decision begins with determining and approving a peer group.
But the way these peer groups are determined needs adjusting. A peer group is supposed to be a group of companies comparable in size and complexity. This definition can result in mostly unrelated businesses being compared. But as The Atlantic argues, these comparisons should be irrelevant. An executive’s competence in one industry has only limited value in another.
Increase Transparency
A simple, yet essential piece of improving executive compensation is transparency. Pay transparency, in general, has been a focus for many businesses over the past several years. But this transparency is especially important for executive compensation.
A survey earlier this year by Mercer reported that 83 percent of companies would take efforts to improve transparency of executive pay. Pay transparency helps employees better understand the reasoning behind their pay structure. Similarly, this transparency can also improve business results through increased brand loyalty, more employee trust, and better organizational alignment.
Learn more about business transparency.
The Wrap
Nobody doubts that an innovative and driven executive team is key to a successful organization. Still, it’s worth examining how, and how much, you are paying these executives. Tweak your executive compensation policy with these four tactics, and improve your business outcomes as a result.
Use your executive pay to keep your best possible business results in play.