Executive Compensation: Set a Clear Course

Executive compensation has been filling the news media and creating a tremendous amount of public debate lately. One major question centers on pay for performance strategies versus pay practices in reality. In other words, at the end of the year did the executive pay strategy result in the desired performance and did it meet budgeted expectations. If not, what were the unintended consequences and what adjustments get made going forward.

Many say executive compensation is more art than science. A formula that works for one company will not work for another. And, a compensation formula based solely on a company’s income statement may not work at all.

At a high level there are three main principles that must be met in order for the compensation strategy to work.

• The program must be achievable.
• The program must be believable.
• The program must create alignment within the management ranks.

If any of these fail, the compensation program will fail.

With the founding principles in place, the starting point has to be the company’s strategic plan. The primary assumption is that the Board and Executive Management fully support the strategic plan. A failure to support the plan will not only derail the compensation strategy, it will derail the entire business. Obviously a strategic plan can include a tremendous amount of initiatives. It is important to narrow the strategic plan down to the 3-5 most critical and measurable activities. These have to be things that the company and executive have control over. The instinct might be to want to include many metrics in the compensation program, but in reality if there are too many measures, nothing gets measured. So instead, narrow the focus and use compensation to drive towards the desired performance.

The last three important elements to consider before finalizing a plan is to make sure there is agreement on the appropriateness of the measures/metrics chosen, make sure the amount of pay is appropriate, and make sure the compensation plan is driving towards the desired performance.

Is there a need to include Internal Audit in something as strategic as executive compensation? Many readers are probably responding, No Way! Before committing to an answer I suggest you consider it this way. Internal Audit’s job is to help the Board and Executive Management identify and assess risk and then help them establish and evaluate a system of internal control to mitigate the risk. I’d submit there is no better independent sounding board than the Internal Audit Department. So, before publishing the compensation program bring in your risk and control expert, and maybe a few of those unintended consequences can be avoided.

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This blog post was written by Steven Randall. Steve is a Managing Partner with Vonya Global, a premier provider of internal audit consulting services, and a Director of the Adler-Caris Foundation, a not-for-profit dedicated to raising funds for Alzheimer’s Disease research. If you would like more information about Vonya Global or if you have a questions for Steve, you may contact him through this blog, the company website, twitter, or his LinkedIn Profile.