Balancing Risk and Reward in Executive Compensation: Competitive with Minimum Risks‍

Casey Fenton

|

January 4, 2024

Main Article Image

Imagine you've finally landed the high-profile executive you've been wooing for months to join your startup. You've offered a golden parachute, a hefty salary, and a substantial signing bonus, convinced that this is the strategic masterstroke that will shoot your company into the stratosphere. Fast forward six months, and it's clear things are not working out. Not only has the executive failed to deliver on key metrics, but you also realize that your overly generous compensation package is now a financial albatross, putting undue strain on your still-maturing startup's resources.

In this scenario, you've learned the hard way that offering a lucrative package isn't enough. The real challenge lies in balancing risk and reward, ensuring you not only attract top-tier talent but also sustain your business in the long run. It's a fine line to walk between being competitive and financially responsible, a balancing act that demands keen attention to market trends, internal goals, and nuanced incentives like Restricted Stock Units (RSUs)

So, how can you offer a compelling package without putting your startup's future in jeopardy? Read on to discover strategies for structuring executive compensation that is both competitive and mindful of risks.

Importance of Risk and Reward in Executive Compensation

Offering competitive compensation is a lever for drawing in skilled executives; however, the stakes are high. If you overpromise, you might put your startup's financial sustainability in jeopardy. Conversely, being too conservative may repel the talent you need to succeed.

Why Should You Care?

  • Talent Attraction: Talented individuals are likely to have multiple offers. You need to provide a compelling reason to choose your organization.

  • Long-term Engagement: Adequate compensation aligns executive interests with the company, ensuring they are invested in the firm's long-term success.

  • Financial Sustainability: You can't afford to bleed money. The wrong compensation strategy may lead to short-term gains but long-term losses.

How to Balance Risk and Reward in Executive Pay

You're faced with a challenge: how to construct an executive compensation package that is both attractive to top talent and sensible for your organization’s financial health. This isn’t a task to be taken lightly; indeed, it’s an exercise in strategic thinking and planning. Below are key steps you can take to find that elusive equilibrium.

1. Initial Design and Planning

Start by laying the foundation. What are your company’s goals, and what kind of performance do you expect from your executives to achieve those goals? These questions should serve as the cornerstone of your compensation package. Create a multi-disciplinary team comprising HR, finance, and strategy experts to ensure all angles are covered.

2. Incorporate Stakeholder Feedback

Before finalizing any compensation package, it's necessary to seek input from various stakeholders, including board members, existing executives, and even shareholders if appropriate. This feedback loop not only creates a more balanced package but also fosters a sense of collective responsibility and buy-in from all parties involved.

3. Use a Tiered System

Consider using a tiered compensation system where you offer a base salary and then additional layers of variable compensation based on performance metrics. These could be short-term incentives like bonuses and long-term incentives like stock options or RSUs. A tiered system helps to tie rewards directly to measurable outcomes, making it easier to justify the compensation cost to shareholders and board members.

4. Dynamic Adjustments

Remember, your initial compensation offer shouldn't be set in stone. Business conditions change, and your compensation structure should be agile enough to adapt. Conduct regular performance and financial reviews, and adjust the compensation package as needed. This ensures that you are continuously aligning the risk and reward elements of your executive compensation.

5. Regulatory Compliance and Transparency

Navigating the legal landscape is essential. Ensure your compensation package is in compliance with any regulations specific to your industry or jurisdiction. Being transparent about your executive pay structure can also serve to enhance your company’s reputation and investor relations.

6. Psychological and Cultural Factors

Take into account the psychological elements that drive human behavior. Recognition and the potential for career development can often be just as motivating as financial rewards. Similarly, understanding the cultural context of your executive team can help you craft a package that resonates with their values and expectations.

7. Evaluate and Iterate

Continuously assess its effectiveness through performance metrics and stakeholder feedback, making necessary adjustments to adapt to new business conditions or objectives.

How Competitive the Executive Compensation Should Be

Deciding how competitive your executive compensation should be isn't as simple as looking at industry standards and matching or beating them. You need to take multiple factors into account, from your own company's financial standing to the talent market and beyond. Here are some guiding principles to help you determine just how competitive your executive pay should be:

1. Conduct a Market Analysis

Start by collecting data from both your direct competitors and the broader market in your industry. Identify the median, lower quartile, and upper quartile pay levels for executives in similar roles. This will give you a ballpark figure for where your compensation should lie.

2. Consider Company Size and Stage

A startup won't be able to offer the same level of compensation as a Fortune 500 company, nor should it. The stage of your company plays a crucial role in determining the competitive level of your executive compensation. For earlier-stage companies, equity-based incentives may weigh heavier than cash compensation.

3. Factor in Geographic Location

The cost of living varies significantly by location. A competitive salary in one area might not be sufficient in another. Make sure to adjust your compensation packages based on the executive's location, especially if you're competing for talent on a national or global scale.

4. Align with Business Objectives

Your compensation package should not only be competitive but also tied to the executive's ability to meet or exceed business objectives. Tailor incentive programs around key performance indicators or KPIs relevant to your company's strategic goals.

5. Assess Talent Scarcity

In fields where top talent is rare, being more competitive in your compensation offer is often necessary. Understand the specific skills and experiences you need and evaluate how readily available (or scarce) this talent is in the job market.

6. Evaluate Non-Monetary Perks

A competitive compensation package doesn’t always have to be about money. Many executives value perks like work-life balance, flexibility, mentorship programs, and opportunities for growth. These can often tip the balance when an executive is choosing between similar monetary offers.

7. Check Internal Parity

While you want to be competitive to attract top talent, you also need to maintain internal equity. Compare the proposed executive compensation package to those of other executives within your company, ensuring that discrepancies can be justified.

8. Be Aware of Public Perception

Exorbitant executive pay can lead to negative publicity and shareholder dissent. Make sure that the compensation package is not only competitive but also justifiable to external stakeholders.

9. Revisit and Revise

Market conditions and the company needs to evolve. Make it a practice to review the competitiveness of your executive compensation packages at least annually, and be prepared to make adjustments as necessary.

How to Mitigate Risks Associated with Executive Pay

Offering a competitive compensation package can be a double-edged sword. On the one hand, you want to attract the best talent; on the other, you can’t afford to jeopardize your company’s financial stability. Here are some strategies to mitigate the associated risks while remaining competitive:

1. Include Clawback Provisions

To safeguard against financial loss due to executive misconduct or underperformance, consider incorporating clawback provisions. These allow the company to reclaim bonuses or other financial incentives if certain conditions aren’t met or if misconduct occurs.

2. Use Performance-Based Metrics

Shift the focus of the compensation package toward performance-based incentives. This aligns the executive’s rewards with the company's goals, ensuring they only receive the full package if they successfully contribute to the company.

3. Establish a Vesting Schedule for Equity Awards

Equity awards, like stock options or RSUs, should have a vesting schedule. This not only encourages long-term commitment but also allows you to evaluate an executive's performance over a more extended period before substantial financial commitments are made.

4. Consult External Auditors

Before finalizing any executive compensation package, consult with external auditors to assess its financial impact on the company. This unbiased review can highlight any unforeseen risks and provide an additional layer of scrutiny.

5. Monitor Industry Trends

Stay updated on compensation trends within your industry. Being aware of how competitors are structuring their packages can give you valuable insights into mitigating risks while staying competitive.

6. Implement a "Say on Pay" Policy

If your company is publicly traded, consider implementing a "Say on Pay" policy, where shareholders have a vote on executive compensation. This not only gives shareholders a voice but also adds an additional layer of accountability.

7. Conduct Peer Comparisons

Regularly compare your executive compensation packages with those of peers in your industry and geographical location. This allows you to gauge whether you're veering into risky territory by overcompensating or undercompensating.

8. Use Caps and Ceilings

To prevent ballooning costs, put caps on bonuses and other variable components of the compensation package. This ensures that you can offer competitive incentives without the risk of costs spiraling out of control.

9. Consider the Tax Implications

Every element of an executive compensation package has tax implications. Work closely with tax experts to structure the package in a manner that is not only advantageous to the executive but also fiscally responsible for the company.

10. Review and Revise Regularly

Finally, continuously review your risk mitigation strategies in light of changing business dynamics, regulatory environments, and performance metrics. Adapt your executive pay structure as needed to align with these evolving factors.

What to Expect When Balancing Competitiveness and Risks in Executive Pay

When you're walking this tightrope, be prepared for:

  • Negotiations: Talented executives will often negotiate. Be ready to justify your offer during negotiations.

  • Market Fluctuations: The competitiveness of your package may vary with market trends. Regularly review and adjust.

  • Stakeholder Concerns: Shareholders and board members will have their views. Balancing their concerns with executive aspirations is an art in itself.

How RSUs Help Strike the Balance

Restricted Stock Units (RSUs) offer a unique advantage in balancing risk and reward. They provide employees with company shares but with conditions attached, usually in the form of vesting periods.

✔ Risk Mitigation

RSUs keep your executives vested—literally. They can only cash in their shares after meeting specified milestones, ensuring their performance aligns with company goals.

✔ Competitive Edge

The promise of future ownership in a potentially lucrative startup can be very appealing. RSUs make your compensation package competitive without immediate cash outflow.

✔ Tax Benefits

For employees, RSUs offer tax deferment benefits compared to other forms of equity, making them more financially attractive.

Bottomline

As you gain experience, take market cues, and align interests through mechanisms like RSUs, you'll find it easier to hit that sweet spot between competitiveness and sustainability. Start reviewing your executive compensation and adjust it accordingly to be competitive with minimum risks, ensuring the long-term viability and success of your venture.

Want in on another industry secret? Leverage equity compensation management platforms! Book a demo with Upstock today and discover why it is the best route for tailoring long-term incentives like RSUs.

Does your team need a boost?

Learn how fostering an Ownership Mindset and with Upstock's Motivational Dashboards can boost motivation and increase retention.

Learn More
ABOUT THE AUTHOR

Casey Fenton

Founder, Upstock & Couchsurfing, AI and Equity Innovator

Casey Fenton, the founder of Upstock & Couchsurfing and an AI and equity innovator, has revolutionized how we perceive and implement equity in the workplace. His foresight in creating platforms that not only connect people but also align their interests towards communal and corporate prosperity has established him as a pivotal figure in technology and community building. Casey speaks worldwide on topics including ownership mindset, worker equity, With Upstock and Couchsurfing, he has demonstrated an unparalleled expertise in harnessing technology for the betterment of community interaction and organizational benefits.

Previous: Striking Equilibrium: Balancing Giving and Taking in the Workplace Setting Next: Best Practices for Communicating RSU Plans to Employees: Ensuring Wealth-building Awareness‍