The price of executive compensation

Executive compensation is back on the agenda. It’s figured prominently this annual general meeting season with investor groups moving to embarrass companies that pay their chiefs too much.

Executive pay is also a vexed issue in the private company space, particularly among medium-sized businesses. How do they judge value for money when it comes to paying top executives? Obviously the capacity of the business is a key factor. Many of them evaluate the remuneration based on history (that is, what they have always paid), adjusted for inflation. Some use industry benchmarks. But what are the more rigorous, scientific measures? And what can private companies learn from their listed counterparts?

Rita Avdiev, managing director of remuneration consultancy Avdiev, says companies need to take in surveys to assess what the market rate is. There are all sorts of ways picking up that information. If companies don’t want to pay for a survey, they could browse the internet and see what sort of remuneration is offered for similar positions. Recruitment company Hays has a free salary guide available on its website.

The Australian Institute of Management does an annual salary survey. One of Australia’s most comprehensive and highly regarded, it sells to corporates for about $2,000. Alternatively, businesses could pick up parts of the survey that relate to a particular position for a cheaper price.

Companies also need to ask key questions, Avdiev says.

“What’s the market value of the position, is he doing a good job, what has been his contribution to the bottom line, is the team stable, has he introduced new systems, are there plans for the future, is there a strategy,’’ Avdiev suggests.

She says the biggest mistakes middle-market firms make are undervaluing or overvaluing the positions. “There are three million ways they can reach that position,’’ she says. “They can do that by not thinking about it or by giving regular increases without having thought of whether they deserved it or not.”

Apart from surveys, companies can use other approaches. As Susan Heron, chief executive officer of the Australian Institute of Management says, it’s all about competitive intelligence.

“For mid-market companies, it’s important that they obtain information about market trends. That can be obtained from recruitment companies and they will be using recruitment companies, so it’s a good idea to have a relationship there,’’ Heron says.

“It’s also important that the CEOs, and if the organisation is large enough and does have an HR manager, are talking to their peers in other businesses. There is nothing like that to get real-time information.

“CEOs talk to each other about strategy, they talk about problems, about staffing and how much they pay. That is a strong way of understanding what the market is actually doing. Sometimes organisations think that the benefits to networking are at the individual level but these are benefits the organisation can get.”

She says small and mid-sized firms need a particular approach to remuneration. “What you need to do if you’re in this SME space is to create a reference framework. [That] can come from the salary survey, it can come from recruitment companies, it can come from your peers within other organisation and for the CEO and HR manager. That should be part of their job.”

Specialists say remuneration rigor is the one area many mid-sized companies lack.

Geoff Berry, from remuneration consultancy The Berry Group, says many SMEs struggle to link performance appraisals to remuneration. He says for SMEs, other factors typically come into play.

“The priority is to attract or retain that person and you will accept the fact that their performance is not perfect because no one is, even if they tell you it is, so your job as a manager is to get the best you can out of that person,’’ Berry says.

He says that is why many private companies struggle to link pay to the performance appraisal.

“Obviously, there should be some sort of linking it but it’s very seldom that straight-forward. On one hand, you want to look at what’s competitive out there in the marketplace and on the other hand, you would want to look at the particular job and the particular individual and you would want to incentivise them and give them realistic feedback as to what they are worth in relation to what’s out there in the marketplace.

“But it’s difficult to be very objective about how you relate the two because of all the personality-type issues that get into it.

“Usually you are either trying to attract a new person or you’re trying to retain an older person and yes, you do have as a consideration their performance, but usually you are looking at a scarce commodity and you don’t want to miss out so you will pay what you can justify in terms of the market rather than getting too wrapped up in the performance appraisal.”

Still, some would say a more rigorous approach is needed and there are companies that provide services for SMEs to rate performance and then relate that to the market rate.

Tim Gullifer, a partner at Deloitte Private, says private companies should look to listed companies on how to manage pay and performance. Listed companies have robust performance management and career planning systems in place. At many listed companies, people’s careers and performance management are assessed every six months.

“That’s expensive for SMEs but it’s not as expensive as making sure they take on a competent HR person with competencies around performance and managing people’s careers,’’ Gullifer says.

He says this is one area many medium-sized businesses ignore, to their cost. “You would be surprised at the number of mid-sized companies that don’t have that position filled,’’ he says.

“They think they have a competent leadership that can manage the talent pool but the talent pool looks to a single point of contact in the business that they can go talk to about their future and other emotive issues around their performance.”

He says that requires the HR team to develop rigorous performance management systems that link pay to performance and all the levers that could include profit, sales, growth, customer satisfaction, customer loyalty, repeat business and staff turnover. Many companies now also evaluate retention of women and conditions for their return to work after having family.

“You need a really good comms strategy that links the ownership and the executives together,” he says.

Also, the key performance indicators that determine bonuses and performance need to be evaluated every year.

An effective performance and career management system is critical for remuneration strategy, he says. “Companies that don’t have performance management assessment criteria in place are the ones that lose their people because they can never explain to them what they are worth in dollar terms.”

In the private company space, the question of ownership and executives is more complicated. With SMEs, the owners also happen to be executives, along with the others they have brought in.

Gullifer says unlike listed companies, many SMEs actually under-pay because their executives are part of the family in family businesses.

“In the SME space, you have to separate the groups that are family members versus the outsourced senior leadership that has been working with the family,’’ he says.

As a rule, the non-family members tend to be paid more and this leads to tensions that need to be tackled. “Family members also participate in employee staff satisfaction surveys and if they don’t see themselves being paid in line with the market for their effort, that will create dissatisfaction and increase disharmony in the family as well,” he says.

In terms of bonuses, he recommends companies add an extra half to the target. So if someone is working for $150,000 with a $50,000 bonus if they achieve 10% growth, that should be extended to 15% growth. The same applies to other levers.

“It’s a good idea to put in stretch KPIs around remuneration,’’ he says. “The view is that people aren’t working as hard as they should be in the executive arena for what they’re getting and the employer should be stretching their targets against growth indicators to help the organisation deliver its ultimate goal.”

Stretch targets make the bonus special and Ann Byrne, the chief executive officer of the Australian Council of Superannuation Investors, says SMEs need to guard against executives treating their short-term bonus as part of the salary. It has to be earned. Also, it’s a mistake to pay the bonus before the company sees any benefit. So if for example the executive has organised a merger, they should wait until the impact hits the bottom line before the bonus is paid.

Still, many mid-sized SMEs will not have HR people on board. If that’s the case, Susan Heron says, the CEO and other managers need to take on the functions of HR people. “If you don’t have a system of assessment, then be comfortable that you have some rigour in how you’re applying it because the last thing you want is for someone who is really valuable in the organisation to challenge what they perceive as your subjectivity and say: ‘I think I’m hard done by because I know someone who is doing something similar in another organidation and they’re doing so much better so I’m out of here’.

“If you don’t have an HR person, then you as a CEO have to become that HR person and think about how you even have those conversations. You need to think beyond the person and look at the resource and that’s something that a lot of CEOs who are taking on this role may not have developed. They may not have that HR aspect developed. They may be very good operationally, very good strategically but in understanding how that comes together for that resource of people, they may not have focused on it.

“If you’re going to do it as a CEO, then you need to invest some time in yourself to develop to make sure that you’re actually on top of this.”