How to craft a sensibly designed and well-implemented executive pay program.
IN JUNE OF 1960, I joined the salary administration department of 3M Co. (it was then called Minnesota Mining and Manufacturing). This was my first position in the corporate world. Salary administration was certainly new to me, and executive compensation was a deep mystery which was beyond my understanding. However, early on in my new position, it was obvious that executives were on a different compensation track than other salaried people.
Since those early career days, I have always believed that there were some guiding principles which could be set forth concerning sensibly designed and well-implemented executive compensation programs. The following principles have evolved from being on "both sides of the table" as a corporate practitioner and more recently as a compensation consultant. These principles certainly should not be viewed as absolutes. Instead, they are considerations which can be used in the development of an effective compensation program for a company's executives.
The executive compensation program must fit the culture and meet the specific needs of the individual organization. This principle, I believe, is paramount. It recognizes the "given" that there are no two organizations which have the same cultures and needs. Some companies have cultural similarities. Also, many organizations have like needs in the structuring of their executive compensation programs. However, individual variations exist and must be reckoned with if the program is to meet the organization's compensation objectives. Therefore, at the very start of the program's development, the designers, be they company executives or consultants, must have a clear understanding of the organization's culture and its specific needs. The process takes time. If this meaningful analysis is not made, the program is prone to failure.
With this overarching principle as our backdrop, here are 10 additional principles, not prioritized in any particular order as they are all believed to be of equal importance.
* Determine how the three major components of the program -- base salary, annual incentives, and long-term incentives (includes stock options) -- fit together and the emphasis that should be placed on each. Many call this evaluation the company's executive compensation strategy. It is an essential evaluation which must be made at the very beginning of the program's development. It is imperative that management expresses its views as to how each component is expected to be used and the weighting for each.
* Beware of the external data trap. Many compensation practitioners have too much of a love affair with external data. They firmly believe that the data very much dictate the program's design. Use the data as it should be used as part of the...