EXECUTIVE REWARDS SYSTEMS
 

 

 

 

 

 

 

 

 

 

 

 

Executive compensation and strategy are mutually dependent and reinforcing. A good reward system should have three characteristics:9 (a) it should optimize value to all key stakeholders, including both shareholders and management alike (the so-called agency problem); (b) it should properly measure and recapture value; and (c) it should integrate compensation signals with those implicit in strategy and structure. Although these issues are generally addressed from the perspective of plan implementation, they also have an important but rarely noted strategic dimension. And that strategic dimension actually has a make-or-break impact on plan effectiveness.

ers and their agents, the executives charged with implementing corporate strat- egy. The executives of a corporation serve as agents of the corporation’s shareholders. Yet, though both executives and shareholders are stakeholders in a corporation, their interests do not coincide. In fact, they naturally diverge on three counts: risk position (e.g., shareholders stand last in line among claimants to the resources of the corporation, whereas executives have the right to payment of salaries and benefits before the claims of shareholders are met); ability to rede- ploy (e.g., shareholders can freely redeploy their investments; the executives’ human capital invested in the course of a career may not be easily redeployable at full value); time horizon (e.g., shareholders embrace long time horizons to earn competitive returns; time horizons of executives are usually shorter).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The agency problem refers to the potential conflict of interest between sharehold- Problem These dif- ferences lead to differences in the ways each group measures the risks and rewards of any corporate action. In general, the differences in risk evaluation make a company’s executives more averse to risk than are its shareholders. Resolving the agency problem requires bridging the gap between the inher- ently divergent interests of shareholders and the executives entrusted with the responsibility of safeguarding and increasing shareholder investments. Though executive compensation plans can and should help resolve this problem, they often compound it. Most incentive plans, for example, are based on improve- ments in short-term earnings; therefore, they actually inhibit the very risk decisions required to provide highly competitive returns to shareholders. New and creative ways of compensating executives must be developed to synchronize their interests with those of shareholders. Hellenic Corporation consists of four businesses: Alpha, Beta, Gamma, and Delta. Alpha operates in a promising market but needs to increase market share rapidly. Beta is an efficient, well-run business that already has the largest share of a mature market. Gamma, once a top performer, has suffered recently from serious management mistakes; nevertheless, it has the potential to be a winner again. Delta is a mediocre performer in a mediocre market; moreover, its busi- ness is largely unrelated to the other businesses of the corporation. Hellenic’s strategic plan calls for Alpha to grow rapidly, for Beta to capitalize on its well-established position, for Gamma to turn itself around, and for Delta to be divested. This plan maximizes the value of the corporation as a whole. Each division is vital to the corporation’s success; however, the management objectives of the chiefs at Alpha, Beta, Gamma, and Delta differ from one another and influence the market value of the firm in distinct ways. This conflict, however, does not mean that shareholder value is an impractical standard for determining executive reward. Even when a manager ’s performance is related only indirectly to share- holder value, increasing shareholder value need not be abandoned as the aim of executive compensation planning. The challenge is to craft a plan that links per- formance to value in a way that is consistent with the corporation’s long-term strategy. To do this requires tailoring a specific compensation package for the manager of each business unit. The determinants of compensation at Alpha must be different from those at Beta, which again must be different from those at Gamma and at Delta.