Three important trends are driving up top level executive pay packets. One is increased competition for global talent, another is an increase in overall performance accountability and third, executives are spending less time in the ‘hot seat’.
When it comes to competition for global talent, New Zealand companies simply can’t afford to pay comparable rates to the United Kingdom, United States or even Australia. But combination of expatriates coming back to New Zealand and offshore talent being attracted to this country has driven management remuneration packages to new levels.
The increase in overall accountability is being driven by parent companies and boards that are now holding executives and their teams more accountable for overall organisational performance.
And, for variety of reasons, it has become ‘normal’ for chief executives and managing directors to spend only five to seven years at the helm of an enterprise. Executives must perform or be replaced. This is driving trend toward linking performance and pay, forcing boards to negotiate more highly leveraged remuneration packages that attract key talent and also tie percentage of the rewards to the achievement of business goals.
With the surge in the value of executive remuneration packages, companies are recognising the need to use remuneration as strategic tool for rewarding senior executives for enhanced company performance. This is evident in the increased use of performance-driven remuneration mechanisms, including short and long-term incentives.
New Zealand organisations have, traditionally, focused on guaranteed income and expensive benefits to attract and retain key talent. This shows up in the high levels of fixed remuneration (base salary and benefits) as percentage of total remuneration in executive packages. This approach provides comfort for individuals, but there is little incentive to push the performance boundaries.
The traditional remuneration package has changed considerably over the past 10 years. The use of incentives is increasing as companies consider more innovative means of ensuring rewards are aligned with performance. Specifically, many organisations have begun to emphasise performance through the use of short-term incentive programmes.
However, the level of sophistication and innovation used in developing remuneration packages is relatively low by comparison with other countries. Innovation typically implies ‘risk’ and New Zealand business has yet to embrace high levels of risk. This is apparent in the short-term incentives for senior management, for example, which averages around 17-20 percent of fixed remuneration in the New Zealand market. Australian and US companies usually structure short-term incentives at 35 – 50 percent… significant difference.
The goal is to continue to increase levels of short-term incentives (thereby increasing levels of risk) while holding fixed costs down. To balance short-term and long-term business objectives and decisions, organisations should consider using mix of short and long-term incentive opportunities. mix drives subtle, healthy tension between short and long-term business goals and better aligns the executive’s interests with those of the shareholder.
Even though pay levels for CEOs and senior executives continue to rise, research suggests strong, positive relationship exists between increases in executive pay levels and corporate performance. There is, therefore, an incentive for parent companies and boards to keep driving stronger link between pay and performance.
Some research suggests that the link is strongest when share ownership is introduced to the package as mechanism for driving corporate performance.
The use of long-term incentives is widespread in the US, for instance. More than 90 percent of companies offer their executives at least one type of long-term incentive opportunity – up from 63 percent just nine years ago.
Australia too has seen significant shift in the structure and design of executive pay packages over the past decade. Long-term incentives now make up approximately 35 percent of the CEO’s total remuneration package.
Not only is the prevalence of the long-term component growing, but its relative value in the total remuneration package has also increased as ‘at risk’ pay becomes more highly leveraged against fixed cost components.
The most common long-term incentives are share option plans, share purchase loan plans and restricted share plans. Of these, share option plans are significantly increasing in both frequency and value in both New Zealand and Australia.
Companies are trying to customise their plans by using performance hurdles consistent with their organisational goals, such as Return on Earnings or Earnings per Share. It is also common to benchmark against other similar organisations thereby relating rewards to performance in the broader industry. This includes indexing against peer groups such as the All Industrials or the All Resources industry groups. These tactics ensure greater alignment to both share value and company performance.
There is increasing evidence of other types of performance-driven remuneration mechanisms. For example, ‘termination payments’ have been used when executives reach the end of their contracts. This payment acknowledges the achievement of key strategic initiatives and objectives, and is used in lieu of the traditional ‘severance’ payment, giving the executive greater motivation to meet the agreed goals.
The link between pay and performance must be strategic. The use of performance-based incentives provides stronger motivational message with greater element of risk (and upside opportunities) than fixed remuneration. It is critical that remuneration be viewed and used as strategic leveraging tool to motivate and reward for performance. How else can organisations clearly show the return on their investment in executives? M
Helene Higbee is director of remuneration consultancy Higbee-Schäffler. Email: [email protected]
Would You Include Risk and Reward in Your Ideal Salary Package?
Management and remuneration consultants Higbee-Schäffler are conducting an “Ideal Salary Survey”. What do you think constitutes the Ideal Salary? This is part four of series of articles on the importance of salary package benefits and we want you to respond to the questions on the survey form in this issue of Management magazine or go to Management’s website at www.management.co.nz.
The questionnaire has been compiled in consultation with Higbee-Schäffler, which will analyse the results and, at the end of the year, compile the data to reveal our readers’ Ideal Salary Package.
Fax back the questionnaire in this issue or visit www.management.co.nz to take part in Management’s Ideal Salary Survey and we’ll email you copy of the complete survey results at the end of the year.
