Establishing the parameters of executive compensation within an organisation is a complex task. The board needs to craft a package which is in line with business strategy and performance and which is of significant value to the executive, or there is a risk that value is lost by both. Compensation is a tool which can be managed to align company success with executive deliverables so as to benefit the bottom line and inspire business executive performance.
Reward expert, Laurence Grubb, Exco member of the South African Reward Association (SARA) explains: “There are three basic types of long term incentive schemes which align shareholders and executive interests and work best over a period of between three to five years.”
Performance share/unit scheme
This type of scheme offers the executive shares or ‘full value’ units which are linked to the value of the company. The total value of the shares or units offered is aligned to the value of the executive’s package. When these vest (become available to the executive), the performance of the company is compared to the performance objectives set at the time they were offered and this determines the number of shares or units that vest and the executive receives the full value.
“The executive is therefore driven to improve the share price or unit value and to ensure the company meets or exceeds the performance objectives set,” explains Grubb.
Share option/appreciation unit/rights scheme
This is similar to the previous scheme but instead of full value units, the executive is offered options/units/rights where they benefit from only the growth in the value. So they only receive the difference between the value at vesting and the value at commencement. There may be performance objectives attached to the vesting or a hurdle, such as a minimum level of company performance, below which nothing vests.
These schemes should ignite executive commitment as benefits are closely tied to the success of the business. “The challenge with this type of solution is that the share price can be impacted by factors outside of the executive’s control and it can be tricky to set the performance measures today for market conditions and organisational objectives in three to five years,” says Grubb.
Share Purchase Schemes
“The third type of scheme aligns executive interest with shareholder interest. Executives are asked to invest their own money into shares so they are completely engaged with the shareholder vision.”
“The ways in which the schemes are structured depend on who the shareholders are and what they prefer, the executives and the expertise within,” says Grubb. “Some companies have their own reward departments with specialists on board to advise them. In other instances executives seek the expertise of outside consultants on how best to construct and manage their packages. In both cases it is essential that the final package align with company strategy and ensure executive buy-in.”
“Linking incentive to reward and reward to performance is an art form and many companies and reward specialists spend a good deal of time and effort in identifying and implementing the best solutions for their business,” concludes Grubb. “You need to define performance and establish which measures – financial and other – evaluate that performance. Companies need to be focusing on making sure that performance criteria are well-defined and that they are as relevant in five years as they are today.”