Model for a considered and responsible remuneration policy

Source: Management Scope (31/10/2018); Author: Xavier Baeten (Professor of Reward Management & Sustainability at Vlerick Business School)

To tackle the much-criticised remuneration policy for top-level managers, Professor Xavier Baeten of Vlerick Business School in Belgium has developed an executive remuneration strategy model that supervisory boards can use to make responsible decisions. He argues in favour of a custom approach and strategic remuneration. 

The question of top-level salaries and bonuses has been fiercely debated in the Low Countries for years. It is impossible to open a newspaper or watch a current affairs programme without finding reports on top-level salaries and bonuses. A mere glance at Facebook or Twitter reveals outrage on the subject. The ongoing problem, in my opinion, is that when awarding salaries and high bonuses – regardless of whether these are ethically accountable – companies primarily consider and hide behind market behaviour. They often fail to ask themselves adequately whether their approach is appropriate in their own company. I have to say that this copycat behaviour astonishes me, because the principle and design of top-level salaries is a perfect opportunity for companies and institutions to demonstrate what they stand for and what they believe is important. That applies both to priorities regarding the senior managers themselves, and regarding employees, stakeholders and society as a whole. It is time for a custom approach, coordination, and a rallying cry: dare to do things differently.

Remuneration philosophy

Working at Vlerick Business School’s Executive Remuneration Research Centre, I have developed a model along with a group of colleagues that is based on input from the field. It is intended to help supervisory boards with the complex issue of what is internationally termed ‘executive reward’ – the remuneration of top executives. I hasten to add that ‘remuneration’ goes beyond the mere handing out of hard cash. Our model is helpful in defining the correct principles for remuneration. It chiefly focuses on a business or institution’s strategic choices, thus enabling any company to develop its own remuneration philosophy or strategy in which rewards are linked to company strategy and the specific company context.

This kind of strategy involves making hard choices, for which the parties need to seek out answers to a series of key questions. Questions such as: with whom do we wish to compare our company? Where are we positioned in the market? Or better still: where do we want to position ourselves in the market? What tools for remuneration do we want to focus on? Shall we opt for a fixed salary or do we wish to build in flexibility? Let us be clear: these are questions to which there is no ‘right answer’. It is about the underlying philosophy or strategy. What works for one organisation will not be right for another. We notice that our model then helps to frame the discussion correctly to allow for a range of opinions to be expressed, whilst also fostering an awareness that decisions do need to be made and that ultimately, everyone needs to be aiming in the same direction.

Five themes

In the executive remuneration strategy model used by Vlerick Business School, decisions need to be made on five different themes. Viewed schematically, our model most closely resembles a Greek temple, a temple with three strong pillars and an elegant frontispiece on top. I will briefly explain the core values and themes that underpin this remuneration temple.

First of all there are the three pillars. These represent the three core questions – and accompanying sub-questions – in the remuneration strategy which require a response.

1/ Criteria for remuneration principles

Pillar 1 of our Greek temple concerns the key question: on what basis do companies want to remunerate? The answer demands a meticulous definition of the criteria based on the company strategy, generally using key performance indicators (KPIs), the indicators that reflect a company’s achievements. Which KPIs do companies actually choose and why? Converting the business strategy and goals into indicators which in turn are further converted into the remuneration policy proves to be a highly complex exercise. Do companies opt for financial or non-financial KPIs? When awarding bonuses, do they focus on profitability and share prices? Or do they look at customer satisfaction or even employee satisfaction? For example, in its remuneration policy, telecom company KPN sets great store by both customer satisfaction and reputation. The retailer Tesco opts for an approach in which great weight is attached to stakeholders. Its remuneration policy focuses on customers, colleagues and supplier satisfaction.

2/ Remuneration mix

Pillar 2 of the temple is constituted by the core question: how do companies remunerate? Here, all manner of sub-questions automatically come into play. What mix do they want? What is the ratio between fixed and variable remuneration? And within variable remuneration, what is the ratio between short-term bonuses and long-term bonuses? Other questions that arise include: what is the importance of a solid pension plan? Or does the proverbial company car – or more exclusively: private plane and penthouse – need to be made available? In addition, it is also essential to consider in advance what is known in Flanders as ‘severance pay’, or in the US and elsewhere as a ‘golden parachute’. Our model is designed to allow companies to make robust decisions on main and side issues, in this case both important and less important remuneration components.

3/ Benchmarking

The third pillar of the remuneration temple asks questions about the positioning of companies. What market is the company operating in and where does it position itself? With whom does the company wish to compare itself and why? Above all, companies need to formulate an answer to these questions themselves and not outsource the task to consultants, as is currently often the case. Perhaps it is not entirely logical for AEX companies to compare themselves to each another when it comes to top-level salaries. These businesses may be better advised to look within their own sector. One example of a company that employs multiple reference frameworks in the remuneration of its senior executives is the pharmaceutical firm GlaxoSmithKline (GSK). For the remuneration of the Chief Financial Officer, GSK looked at his colleagues in companies on the same stock market index; for the remuneration of the Chief Innovation Officer, comparable functions in the pharmaceutical sector served as a guide.

Core values

The three pillars of the Vlerick Business School model are now in place. Time to look upwards to the frontispiece erected above the pillars. It is here that the true core values of a company can be found: the executive reward principles and executive reward governance, remuneration principles and the way in which decisions surrounding these principles are made.

One key point when considering the remuneration principles is to determine the extent to which a firm is aiming at equality at the top level. To foster collegiality, electronics firm Apple has opted for uniformity in the salaries of all senior managers, with the exception of the CEO, although the company is well aware that the market will pay different salaries to CFOs and CHROs. Other key principles: to what extent do businesses aim for executive share ownership in the long term? And: to what extent do they want remuneration to fluctuate with performance?

There is also an administrative side to the remuneration discussion. For example, with regard to decision-making around remuneration, the question of how much freedom a supervisory board should be given must be considered. What discretionary powers does the supervisory board have? Recently the word ‘discretionary’ has been cast in a bad light, but there is nothing wrong with a supervisory board that decides with good reason not to pay out a bonus or to make other adjustments. Companies can also opt for investor engagement, where they actively enter into discussion with investors and shareholders and ask for input. Finally, this aspect of remuneration philosophy also involves considering how transparent companies wish to be. That is also a choice where it is essential for a supervisory board to form a clear opinion.

Colour

Unequivocal answers to all these questions do not exist. For every company, the outcomes will be different. Listed companies will probably be more inclined to opt for remuneration in the form of share packages. Innovative companies will be in favour of rewards based on product development. Still other companies believe in rewarding projects with a strong strategic focus. There will also be businesses that (continue to) choose pure, unadulterated profitability.

In any case, the tool for making a considered choice exists. Our ambition is to engage in debate with supervisory boards on this issue, based on the questions and themes outlined above. It is time to inject some colour into remuneration strategies.

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