Executive Compensation Practices & Trends

Compensation issues are increasingly in the news, and as investors we know importance of having the right programs to attract, retain and motivate the very best talent. Here are some thoughts on a few best practices and commentary on the current trends we are seeing.

Base salaries have remained steady with the increased availability of talent, particularly in some industry sectors. Where overall compensation increases have occurred in 2009, some have been deferred until mid-year to ensure affordability. More confidence for the coming year and improved performance expectations should allow for modest base salary increases.

Short term incentives remain a key way to align behavior to business strategy and specific performance objectives. Bonus targets continue to be closely tied to key financial metrics, and qualitative objectives help in focusing on the longer term. Stretch targets have provided upside potential. Across our portfolio, EBITDA, EPS and operating cash flow are usually selected as performance measures with underlying revenue growth being a key explicit or implicit assumption. More than half of our portfolio companies surveyed have qualitative measures in addition to quantitative objectives. These can include metrics driving business strategy such as customer satisfaction, employee retention, targeted executive hires and performance by region. A focus on clear thresholds and caps avoid dysfunctional scenarios of no downside, unlimited upside or "bet the company" risks.

Long term incentives are shifting from time-based equity awards (stock options) to performance based equity programs (options or RSUs). When tied to performance, developing the right metrics is important. Annual overlapping grants and delayed vesting all provide additional retention elements. It is more common to see longer vesting periods of 3 to 5 years with a cliff vesting after a two year waiting period. Ownership guidelines and/or requirements for public company executives are common and are important to consider for pre-public companies.

The most effective programs are straightforward in approach and implementation. While there is no "one size fits all" compensation plan and you have to match your talent and capability to the market, the process and methodology for performance based systems should be clear and understandable. Complicated formulas create confusion and allow for "gaming."

We expect new regulations to call for even greater transparency in public reporting of compensation, so attention to compensation strategies will only increase. Comparisons among companies and executives will remain fraught with complexities related mostly to the measurement, valuation, granting, exercise and realization of long term incentive programs. Balancing short term results with longer term value creation, and mitigating risks along the way are, and will be, the main challenges for any good program.

The underpinning for any compensation program is an updated business strategy. It is difficult to define a program to motivate the right behavior without clearly articulating the goals of the company both near term and over the next 3 to 5 years. In this uncertain environment an updated strategy is more important than ever. Time up front for the overall strategy and supporting financial models will make it much easier to align the objectives of individual business units and functions throughout the organization to achieve the right results. A discussion of risks and ways to mitigate risks are an integral part of this critical exercise. Overall growth and profitability goals are essential and an understanding of what specific initiatives will get you there.

Investors and boards will continue to be focused on compensation as a key factor to motivate executives and align rewards with value creation. Regulators and shareholders will demand greater transparency in communication of targets and performance measurements. There will certainly be more attention to long term incentives that include performance-based programs, appropriate vesting and stock ownership guidelines. If you would like more detailed information on best practices and compensation trends, please reach out to your GA team.