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Home > Corporate Governance Best Practice > Executive Rewards: Ensuring That Financial Rewards Match Performance

Corporate Governance Best Practice

Executive Rewards: Ensuring That Financial Rewards Match Performance

by Shaun Tyson

Executive Summary

  • Executive pay is used to attract and retain executives, and to drive performance.

  • Business strategy objectives are cascaded down the organization and used as performance targets for the variable element in the reward package, in order to provide a clear line of sight.

  • Reward packages for executive pay include base pay, short-term incentives, benefits, long-term incentives, and perks. Base pay is determined by the market rate in similar organizations.

  • Variable pay incentives usually take the form of an annual bonus scheme, or, in the case of long-term incentives, deferred bonus and/or stock option plans.

  • Reward packages are decided by remuneration committees as an important aspect of good corporate governance; the decisions are made by nonexecutive directors, with transparent reporting in annual reports. In the United Kingdom stockholders vote on the report.

Introduction

Effective management of executive rewards resides at the heart of a network of pressures and issues of central relevance to the management of organizational performance. These pressures can be represented diagrammatically to show how stockholder interests and corporate governance issues impact on business performance, objective setting, the motivation of executives, and the position of the organization as an employer in specific labor markets; and how all of these are affected by corporate values/culture and vision (Figure 1).

However, the economic events of 2008 have reminded us all that these issues are conditioned by the broader economic climate in which corporations operate, where survival is more risky and uncertain irrespective of size, sector, or ownership structure. The rapid disappearance of banks such as Lehman Brothers, the exposure of massive manufacturers such as General Motors, Chrysler, and Ford to recessionary problems, the collapse of house prices, of normal financial processes, and of currencies means that organizations are facing a strategic inflection point, which is affecting all aspects of reward. The topic of executive rewards must be seen as a dynamic field, and this caveat informs all that follows. Nevertheless, there are systematic and enduring influences in the linkages between reward and performance.

We will examine rewards to show the major impact of reward policies and practices on organizational performance. This article takes rewards from the organizational perspective, and the starting point is an examination of the significance of corporate values, vision, and the culture of rewards.

Corporate Values/Culture/Vision

Corporate values and vision statements are an explicit expression of the formal values and vision of the organization, including the sometimes implicitly preferred behaviors and attitudes of managers in their leadership roles. These values may be published but, if not explicitly stated, will still emerge in the actions of senior managers and the founders. The objectives of a reward policy can be summarized as:

  • Building stockholder value (or sustaining value for the citizen in the public sector).

  • Being competitive in the recruitment of executives.

  • Motivating and retaining executives.

  • Being cost-effective.

  • Being seen as fair by employees.

  • Providing a degree of security for employees.

How these objectives are interpreted in any organization is contingent on that organization’s values and the nature of its objectives—for example, profit maximization, market share, and service provision.

A number of authors have suggested that there are specific best practices to drive a philosophy of rewards that will support the corporate vision. For example The New Pay, by Schuster and Zingheim (1996), was a reward ideology that emphasized the strategic role of rewards and the supremacy of the marketplace. Key features of The New Pay were:

  • Emphasis on external market-sensitive pay rather than annual increases.

  • Risk-sharing partnership with employees rather than entitlements.

  • Variable, performance-based pay.

  • Flexibility in pay systems.

  • Lateral promotions rather than career paths.

  • Employability, not job security.

Later, the same authors argued that there are general reward principles that include aligning rewards with business goals; extending the “line of sight” of all employees to see the relationship between individual performance, corporate performance, and their rewards; and recognizing the market value of the individual with base pay, while rewarding results with variable pay (Zingheim and Schuster, 2000).

These ideas have gained currency over the last 20 years. Even though the economic storm now raging across the globe challenges some of this received wisdom, the ideas remain consistent with the prevailing concepts of market capitalism.

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Further reading

Articles:

  • Balkin, D. B., and L. Gomez-Mejia, “Matching compensation and organizational strategies.” Strategic Management Journal 11:1 (1990): 153–169.
  • Cascio, Wayne F., and Peter Cappelli. “Lessons from the financial services crisis.” HR Magazine 54:1 (2009): 46–50.

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