Compensation Packages That Actually Drive Performance

Principles for designing executive pay

by

and

Metin Aksoy

by

and

Metin Aksoy

From the Magazine (January–February 2021) · Long read

Kevin Twomey

Summary.

By aligning executives’ financial incentives with company strategy, a firm can inspire its management to deliver superior results. But it can be hard to get pay packages right. In this article four experts break down the key elements of compensation and explain how to put them together effectively.

When designing packages, boards must make decisions about the proportion of fixed versus variable pay, short-term versus long-term incentives, cash versus equity, and group versus individual rewards. Many look at the copious data available on executive pay and benchmark their plans against those of their industry peers. The mix is also driven by company size, region, culture, and risk appetite.

A good plan always begins with a firm’s strategic goals, however. Is the company striving for profitable growth, a turnaround, or a transformation? Is it trying to compete with public companies as a private entity? Each scenario calls for a different plan design.

The Covid-related economic crisis may also alter plans. If targets become unachievable, incentives will lose their power and need to be revised—offering firms a chance to incorporate measures that serve stakeholders’ interests better.

Idea in Brief

The Finding

When executive pay is structured to align with corporate strategy, it can drive better performance.

The Challenge

Many firms struggle to achieve this alignment, and only a few best practices work in all situations.

The Recommendation

The company must start with a clear strategic objective and then consider several trade-offs as it designs compensation packages.

Decisions about executive pay can have an indelible impact on a company. When compensation is managed carefully, it aligns people’s behavior with the company’s strategy and generates better performance. When it’s managed poorly, the effects can be devastating: the loss of key talent, demotivation, misaligned objectives, and poor shareholder returns. Given the high stakes, it’s critical for boards and management teams to get compensation right.

A version of this article appeared in the January–February 2021 issue of Harvard Business Review.

BG

Boris Groysberg is a professor of business administration in the Organizational Behavior unit at Harvard Business School and a faculty affiliate at the school’s Race, Gender & Equity Initiative. He is the coauthor, with Colleen Ammerman, of Glass Half-Broken: Shattering the Barriers That Still Hold Women Back at Work (Harvard Business Review Press, 2021).
bgroysberg
SA

Sarah Abbott is a research associate at Harvard Business School.
MM

Michael R. Marino is a managing director at FW Cook.
MA

Metin Aksoy is a managing director at FW Cook.

Compensation Packages That Actually Drive Performance

Idea in Brief

The Finding

The Challenge

The Recommendation

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