Strategic Pay Solutions for Today's Tough Challenges |
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Throughout most sectors of the
economy, there is a pervasive sense
that the party is over. While this
appears to be true for many, the
current economy and the uncertain
stock market present a whole
breadth of new opportunities.
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 For the managers and Boards of
public companies, one of the
opportunities is to re-focus around
fundamentals. There are ways
and means of using pay to help
get everyone back to the basics
of creating real and sustainable growth in
shareholder value.
We maintain that the universal starting
point in pay design is company strategy.
While today's environment offers a host of
complications - ranging from a severely mixed
bag of still-rising stock prices, to dramatically
declining stock prices, and just plain, volatile
stock prices - pay must still be linked to the
actions required to realize value.
The following five scenarios outline many
of the challenges facing companies today, with
some thoughts on how to get started, especially
from an executive compensation perspective.
Whatever the situation, the right solution
must be led by the business case. Quick fixes
are just that - they cannot be considered a
substitute for re-thinking the compensation
design vis-à-vis the current and future realities
of the business.
One-time "silver bullets" can be fatal to the
organization's long-term health and success. |
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Most of the attention on the pay
programs has focused on underwater
options. Nevertheless, companies in this
type of situation can benefit tremendously
by introducing both annual and long-term
incentives focused on the few key performance
measures that are the levers of a new strategy.
The stock market's response to a strategic shift
may well be delayed; the market may require
sustained signs of success before it rewards a
company with renewed interest.
Annual and intermediate plans that pay
in cash or in a stock with a low basis can be
effective tools in galvanizing a management
team around a new strategy.
Indeed, companies in this position also
need to address their underwater options.
Some options may need to be replaced, which
is not easily accomplished under the current
and future accounting rules. The investment
community will be scrutinizing overhang
(the sum of options currently granted and in
employees' hands plus the remaining shares
authorized to be granted to employees).
To manage overhang to a lower level,
many companies must find ways to cancel
outstanding options if they are going to replace
them with new options that have a realistic
chance of being valuable to the holder.
Finally, companies undergoing strategic
surgery also need specialized pay packages
to help manage the attrition and attraction
of talent. Some individuals' skills may be
redundant in the new business model, and
therefore will need to be managed out. Other
individuals may be important in a transition but
not in the long term.
In addition, new skills that are not resident
currently in the organization may be required.
Tailored severance packages, stay or
project-completion bonuses, and new hire
packages may all be required simultaneously to
address talent issues. |
 SCENARIO 1:
Stock price in the tank; strategic overhaul underway
The last few years in Asia (particularly in
India and China) have been similar to those
of the heady times in the Silicon Valley
during the late 1990s and early 2000s.
On a similar premise, many organizations in
Asia have ventured into a public stock offering.
Yet, very few start ups and project-based firms
across the region have made money, given that
the launch of the public offering was based
on the promise that all their projects will be
executed on time.
The rise in these organizations' market value
was stunning. The profitable and immediate
success of their planned revenue and profit
models was similarly impressive during a time
when clicks and eyeballs and promises from
renowned business leaders were, to investors, a
sufficient proxy for future profits. But the model
has quickly become challenged, and revenue
from planned projects has dropped precipitously.
Today, many of these organizations are
contemplating replacing current executives and
are in the midst of overhauling their business
model. Shares for many of these firms are
trading some 75 percent off their peak and
some are even trading below book value.
These types of companies are prime
examples of organizations that could use pay
as a significant lever in affecting a turnaround.
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SCENARIO 2:
Business model is okay, but needs
near-term adjustments to weather a downturn
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To understand this scenario, consider the
example of an India-based homebuilder that
is well positioned for the long term, or so
it seems. The prospects for home building
are strong. The company's target customer
segment has good long-term prospects.
Its land inventories are plentiful and bear
moderate carrying costs. Its execution
ability is strong and improving.
Despite the positive horizon, a potentially
serious threat exists: several of its geographic
markets are being hit hard by layoffs,
particularly in areas where technology is a
large employer.
From a business perspective, the company
needs to re-balance its focus. Where it
previously wanted maximum growth from each
of its geographic divisions, it now wants to
refocus on those markets least affected by the
downturn.
It needs to manage its risk in other markets
by slowing its building activity and shifting
from a spec-build mode to build-on-order
approach. It is also keen to use these market
circumstances to increase its share and
presence in key still-growing markets.
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Finally, without taking wholesale hits to its
organization, it inevitably must tighten its belt
and shrink expenses to help maintain margins.
From a talent perspective, the company's
challenge is to quickly refocus the organization
on these near-term priorities. To use pay to
this effect, the company first needs to alter its
annual incentive plans to reflect the need for
focus on margins.
It also needs to shift away from a "one size
fits all" approach for its geographic division
plans. Those divisions in still-growing markets
may be relatively untouched, although market
share may be added as a measure of success,
while margins might receive increased weight
as a balance.
In the challenged geographies, the division
management teams need to be re-focused
away from all-out growth in volumes and
revenue. Profit per home and margins may
take precedence over the top line. At the same
time, local management may be encouraged to
stockpile land inventory, taking advantage of
falling land values, even though the increased
carrying cost hits the short-term P&L.
As far as pay mix is concerned, a shift to
more variable pay may be in order. When a
greater percentage of pay is delivered through
variable means, pressure on salary increases is
lower, and salaries may be held flat. Instead,
target annual incentive amounts may be
increased, leaving the company with a more
leveraged pay program.
Equity programs might be largely
unaffected in this scenario. While option
holders may be disappointed that older grants
have gone underwater or lost much of their
positive spread, a strong communication
program can explain how standard grants
made during this time could have a big upside.
In some cases, targeted restricted stock
grants may be granted to key strategic
contributors, but the grants should be severely
limited for maximum impact. |
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 SCENARIO 3:
Business is performing well but the stock price is caught in the downdraft
Perhaps one of the most frustrating
positions to be in today is to be part
of the team leading a company to
sustained success but, nonetheless,
having the stock caught in the
downdraft.
The large majority of non-financial
services related firms across the region
have been recording sustained quarter-over-quarter improvements in their
earnings but are still getting penalized
in their stock price.
The business implications for
companies in this position are largely
to stay on course while the investor
relations experts try to get the
investment community to notice.
From a talent perspective, the
challenge is to maintain the motivation
of the whole team and hold on to any
key executives who may be at risk.
One of the dangers that companies
face in this scenario, and even in some
turnarounds, is the near panic over
what it will take to keep a team focused
and in their seats. |
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Companies may selectively restake
or provide retention grants
(usually restricted shares), but should
do so cautiously. If they choose
this course, they may find later that
they have another problem, namely
multi-millionaires with new and
very high expectations about what a
compensation program should deliver.
Communication should be the
first line of defense. The elements of
an effective communication program
include financial education that
highlights the continued growth
opportunities in share price drivers
(e.g., earnings before interest, taxes,
depreciation, and amortization
[EBITDA], return on capital employed
and top-line growth potential) along
with historic bands of valuation for
the sector.
This understanding can help option
holders develop their own view of the
stock's future potential and the gain
opportunities therein. This will help
build recognition of the future spreads
that may be achieved on new and,
potentially, on earlier, option grants.
From a talent perspective, the challenge is to
maintain the motivation of the whole team and
hold on to any key executives who may be at risk |
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 SCENARIO 4:
Company stock underperforming in the wake of mixed unit performance
A tough stock market may be especially unkind
to companies that are perceived to have a mixed
or unfocused portfolio of businesses.
For example, a leading Chinese organization, a
diversified manufacturer with multiple autonomous
business units, had a track record of creating
significant shareholder wealth. However, it needed
to continually demonstrate a strong growth
trajectory to drive shareholder value even further.
With a perception among analysts that it was
too patient with some of its units, the company
sought to find a way to sharpen focus across the
board and get all of its businesses operating with
full margins and on good growth trajectories.
In this scenario, the company needs to
refocus the organization on key value drivers and
milestones plus do so with greater line of sight to
the results that managers can impact.
In this example, the company knew it needed
to achieve growth at the business unit level. A
history of small, independent business units had
left the company with weaker accountability than it
thought was desirable.
There was also a sense among the various
management teams that their decisions and
actions had limited impact on the stock price.
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To encourage stronger growth in each of its
business units, the company introduced a two-part
long-term incentive plan.
Part one was based on a matrix that measured
a business unit's real earnings growth and return
on investment performance.
Payments within the matrix were calibrated to
actual value creation and then "tilted" slightly to
encourage growth over return on investment. (The
business units had historically been conservative
and valued returns over growth. The new payout
matrix sought to reinforce growth.)
This part of the plan measured each business'
contribution to shareholder value and represented
the most significant opportunity in the two-part plan.
The second part of the plan provided annual
non-qualified stock option grants. The grants
reinforced the tie to overall company results as
well as the need to translate individual business
performance into long-term shareholder value
creation.
Finally, the company made some adjustments
to annual incentive programs for business unit
leadership, introducing milestones related to
identifying and opening up growth opportunities.
While education and communication around
stock price potential plays a part in this scenario,
the emphasis is more internal (e.g., getting
managers focused on what they do that drives
shareholder value). |
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 SCENARIO 5:
Economic downturn prompts portfolio adjustment or redeployment
The last business cycle seemed to
emphasize the market's attraction to
"pure plays".
Private equity investments, spinoffs,
and divestments of businesses
reached record levels in many parts
of the world during 2005 to 2007.
Nonetheless, record mergers and
acquisition activity also led to the creation of behemoth organizations
designed to achieve broad dominance and synergy.
Most of these behemoth organizations will find assets that do not
fit or cannot meet their performance expectations. A new wave of
spin-offs and divestitures will ensue, which is exactly what we have
been witnessing in the recent past across the globe.
Spin-offs and divestitures each present their own sets of issues with
regard to keeping talent and keeping talent focused. Some business
spin-offs or sales present 'trophy assets' to a new owner (or set of
owners), but the management team is not always part of the trophy.
Management teams may be needed through the transaction but
not wanted after it. Conversely a strong management team may
greatly increase the value of the asset in question.
The importance of the management leads to a wide variety of
possible approaches for the seller.
On the short end, it may require nothing more than stay bonuses
to get through a transition.
Other permutations vary with the form
of the transaction and may include a stake
in the sale price, a re-staking in the buyer's
entity or in an actual public offering, or a
whole new set of equity programs geared
both to the IPO and the long-term success
of a new, independent entity.
Shekhar Purohit is a
Principal at Hewitt and is
the Asia Pacific leader for
Executive Compensation
and Corporate Governance.
shekar.purohit@hewitt.com |
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Hewitt Quarterly Asia Pacific
is made possible through the combined skills and experience of Hewitt consultants from across the Asia-Pacific region.
For further information please contact:
Hewitt Associates
2601-05 Shell Tower
Times Square
Causeway Bay
Hong Kong
Tel: (852) 2877-8600
Fax: (852) 2877-2701
editor-hqap@hewitt.com |
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