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Radical Changes in Compensation Design
(Revisited)
Then and Now
HR Network
15 September 2005
Fred Whittlesey, CEP, CCP
Principal
Compensation Venture Group
Bainbridge Island, WA
206-780-5547
[email protected]
Today’s Presentation

The current total compensation landscape

Revisiting: then and now

Action steps for the coming year
In the past two years the compensation landscape has
experienced unprecedented upheaval and change



Stock-based compensation accounting changes are final…but changing

SEC is active in guidance and interpretation

Affects total compensation strategy in all organizations
Deferred compensation regulations are released…and evolving

Interaction with accounting rules on certain issues

Private companies with long-term incentive and deferral plans are
disproportionately affected
Director and executive pay levels continue to soar while rank-and-file pay
stagnates or shrinks

Scrutiny is continuing to increase
In the past two years the compensation landscape has
experienced unprecedented upheaval and change

Significant governance-based compensation “rules” have been issued…and
are changing

Evolution of Sarbanes-Oxley influence

Growing prominence of shareholders and their advisors

Self-appointed standard-setters have emerged

Nonprofit organizations follow compliance with intermediate sanction rules
with voluntary Sarbanes-Oxley compliance for pay processes

Litigation seeking repayment of executive pay has been filed, settled…and is
in progress

Next phase may extend to all-employee issues (e.g., accelerated vesting
of options)
In the past two years the compensation landscape has
experienced unprecedented upheaval and change

Continued increase in true globalization has affected pay patterns…but is only
beginning


IPOs return but there is even greater activity in private equity transactions


Unprecedented supply/demand imbalance among countries for engineering
and IT talent
Low growth in equity values plus high regulation lead to a cost-cutting value
creation strategy
Substantial consolidation in both troubled industries (e.g., airlines) and mature
sectors (e.g., software)

Transition payments have become a significant proportion of employee pay
amounts
The rate of change keeps accelerating
Just this week

Katrina’s impact on local pay rates in affected cities?

Major HR consulting firm (publicly traded)



No more free lunches for employees (didn’t they read about Google?)

Substantial increase in employee cost for health benefits

Termination of global profit-sharing plan
FASB and SEC announcements on accounting

SEC: “No” to Cisco idea

SEC: OK to “experiment” with valuation

FASB: backpedaling on grant date ruling
Treasury Department 409A guidance due today or tomorrow

Rumored to be a 150+ page addendum to the original 50-page guidance
Where Have We Come From?
The bubble now looks
like a “blip” versus the
long term trend but
artifacts of the bust
continue to affect pay
Review: Four Elements of Compensation
Cash
Wage and salary
Target-based incentives
Activity-based incentives
Discretionary payments
Liquidation of other forms of pay
Deferred cash (savings/retirement)
Equity
Grant
Option
Purchase
Common
Second class
Preferred
Convertible
Goods and Services
Health and welfare benefits
Work tools
Leisure items
Education and training
Social activities
Time and Place
Paid time off
Unpaid time off
Work schedule
Work location
Location rules
Location value
All of these are “back on the table” due to
stock-based compensation discussions
Revisiting the “Then and Now”
From…
Cash
Throwing cash
at the problem
• War for talent
• Emergence of
“hot skills” pay
• Counter-offers
and threat
responses
• Large sign-on
bonuses
• Incentive
guarantees
• Aggressive
upside on
incentive plans
To…
Conserving cash
in the downturn
• Layoffs
depressing
market salaries
• Reduction in
increase budgets
• Incentive targets
missed, cash
compensation
plummets
• Severance
packages scaled
back
• Retention
bonuses for
restructuring
And Now…
Reducing cash and
Restoring cash
• Executive pay
repayments
• Voluntary
executive
“zero pay”
• Outright pay
cuts
• Reduction or
elimination of
employer
retirement
contributions
Revisiting the “Then and Now”
2003
Cash
Reducing cash and
Restoring cash
2005
• …through litigation
• Executive pay
repayments
• Cosmetic (Apple) and reversed (Cisco)
• Voluntary
executive “zero
pay”
• Growing
• Outright pay
cuts
• Reduction or
elimination of
employer
retirement
contributions
• Industry-specific
…and…
• Increasing turnover systematically
raises cash compensation levels
without increases
• Merit increase programs still broken
and receiving more scrutiny from CFOs
Total Compensation Tactics: Then and Now
From…
Goods
and
Services
More for
everyone
• Every benefit
and perk
imaginable
• Flexible and
individualized
benefits
• Employer-paid
benefits
• Mega parties
To…
Less for most,
none for some
• Popular criticisms
of dot-com
excesses as basis
for cutbacks
• Continuing shift to
employee costsharing and
responsibility for
benefits
• Layoff lounge and
x-websites
sponsored by
employers
And Now…
You’ll get nothing
…and like it
• “Your job is your
perk” mentality
• “Consumer-driven”
benefit programs
• Budget constraints
limiting social
activities
• Reduction in
human capital
investment through
training cutbacks
Revisiting the “Then and Now”
2003
Goods
and
Services
You’ll get nothing
…and like it
• “Your job is your
perk” mentality
• “Consumer-driven”
benefit programs
• Budget constraints
limiting social
activities
• Reduction in human
capital investment
through training
cutbacks
2005
• Payback time – turnover is up and we still
don’t measure the cost of it…so we cut
costs for programs and end up increasing
turnover
• CDHP, HRA, HSA
• I didn’t want to go to your stinkin’ party
anyway….I’m outta here
• Included in the “total rewards” portfolio
calculation – sure you can go to
training…if you didn’t want that bonus
…and…
• Increase in “voluntary benefits”
• Self-managed training funds
Total Compensation Tactics: Then and Now
From…
Equity
Expanding the
employee
ownership model
• Mega-grants of
options
• Expansion of
all-employee
plans
• Rapid global
expansion of
equity
participation
• Ownershipbased
retirement
vehicles
To…
Rescuing the
employee
ownership model
And Now…
Questioning the
ownership model
• Repricing and
option exchange
programs
• Renewed debate
over ownership
effectiveness
• Unusual option
grant amounts
and timing
• Questioning of
equity-based
retirement vehicles
• Increasing
aversion to equity
addressed with
restricted stock
• Penalty and
protection
legislation
• Option-expensing
tail wagging the
strategy dog
Revisiting the “Then and Now”
2003
Equity
Questioning the
ownership model
• Renewed debate
over ownership
effectiveness
• Questioning of
equity-based
retirement vehicles
• Penalty and
protection legislation
• Option-expensing tail
wagging the strategy
dog
2005
• Disagreement over options vs. RS/RSU
• Mixed feelings about ESPPs
• Knee-jerk removal of employer stock from
401(k) plans
• New “rule” makers
• The #1 issue
…and…
• Rules still changing weekly around the
globe
• Workers still need to accumulate
capital
• Flat equity markets in many sectors
may be the only real issue
Total Compensation Tactics: Then and Now
From…
Time
and
Place
To…
And Now…
Recognizing the
New Economy
Recovering from
the New Economy
Dealing with
the Economy
• Employees
dictating time
and place
• Return from dotcoms to traditional
employers
• Sabbaticals,
telecommuting
• Appreciation for
the old economy
• Temporary
increased
leverage for
employer
• Flexible
workforce
• Voluntary unpaid
time off as cost
reduction
• Pets at work
• Delayed and
rescinded offers
• Mandatory
unpaid time off
Revisiting the “Then and Now”
2003
Time
and
Place
2005
Dealing with the
Economy
• Leverage has increased – now the
location is outside the US
• Temporary
increased
leverage for
employer
• Market has rebounded but unevenly
• Delayed and
rescinded offers
• Mandatory unpaid
time off
• Some elect permanent unpaid time off to
prove a point
…and…
• Employers accommodating flexible
location have significant competitive
advantage for high end of talent market
• Sensible Startups are attracting talent
again
The Old Way and the Radical Future
Time & Place
Capital
Accumulation
• Employer-tolerated flexibility
• Constrained by performance mgmt.
• Limited by occupation
• Employee-mandated location
• Rigorous performance management
• Technology erases limits
• Employer contribution/match
• Equity through options
• ESPPs in tech sector, F500
• EE funded, externally administered
• Equity = performance-based grants
• Purchase requirements for inner core
PROGRESS
Time & Place
B
Capital
AccumUlation
TBD
Other
G&S
G&S:
Health &
Welfare
Benefits
Variable
Pay
Base
Pay
• ER-sponsored and paid
• Little/no EE input
• Common denominator approach
• Internal market by employer
• Flexible work tools integrated with T&D
• Funded pool for T&D, social
•
•
•
•
Employer-sponsored
Primarily employer-paid
Increasing cost-sharing
Newer voluntary benefits
•
•
•
•
Employer-enabled alternatives
Employee-obtained
Employee-paid
All voluntary benefits
G&S: H & W
Benefits
•
•
•
•
Add-on component
No real “risk”
Minimal leverage
Corporate, group, individual
•
•
•
•
Integrated component
Full risk
Substantial leverage
Corporate cash flow
Variable Pay
•
•
•
•
•
HR-driven process
Survey data from consultants
Salary ranges
Annual increases
Promotional increases
•
•
•
•
•
EE- and ER-driven
Real-time data from EE and ER
Dynamic market points
Continual review
Fixed/variable
Other G&S
Base Pay
D
B
C
Base Pay
D
How the Radical Future Might Look
Time & Place
• Service-level agreements with employees
• Increased rigor and complexity of performance management processes
• “The virtual front desk receptionist”
Capital
Accumulation
• Equity through options and stock awards to EEs and non-EEs
• Long-term vesting with performance-based liquidity opportunities
• Personal pension plans to accumulate value
Other
G&S
G&S:
Health &
Welfare
Benefits
Variable
Pay
Base
Pay
• Annual fund for employee
• Capitalization approach to T&D with repayment requirements
• Formal social activities optional, outsourced to associations
•
•
•
•
Employee-paid
Provided through non-profit private-sector benefits organizations
Online markets to increase efficiency when employees change jobs
Revisions in government regulation to preserve subsidies
•
•
•
•
Core of annual cash compensation
Evolves to be larger amount than base pay
Multiple parts – performance, retention, results-sharing
Ongoing adjustments (+ or -) linked to business conditions
• Established as “initial rate”
• Off-cycle market adjustments in reaction to real-time data
• Used to fund benefits costs and retirement savings
About Predictions: 1990 and 2005
• Require executives to hold stock
options for a longer period before
exercising
• Executive ownership guidelines by
institutional investors and advisors – 3
to 5 years
• Require executives to continue holding
shares acquired through stock options
and stock award plans
• “Retention ratio” as an ownership
accumulation method
• Eliminate the cancellation and
reissuance of options (repricing)
• FAS123(R) encourages fair value
repricings; options to RSU and cash
• Grant large options at the beginning of
a period and eliminate annual grants
• Mega-grants at hire and for retention at
executive level are the norm
• Consider paying executives only in
stock with special arrangements to
provide the necessary cash flow for
living expenses
• Limited “heroic” instances
Fred Whittlesey
“Fixing the Executive Pay Problem”
Los Angeles Times Viewpoints
May 27, 1990
The surveys and the headlines miss the overarching stories

HR is losing control of compensation and benefits function

Total compensation costs are highly visible at Board of Directors level

Americans are overpaid in a global economy


The airline industry drama will be played out in nonunion sectors

The collective action mechanism will be technology rather than unions
Technology finally having a visible impact on the employment relationship
Resource allocation is, and will continue to be,
a crisis issue for HR
Action Steps
Repeat after me: I am a financial professional, I am a financial professional
1.
2.
3.
Understand the financial dynamics of HR expenditures

Total compensation cost and sensitivity analysis

Turnover cost

Financial impact of every HR program
Get the correct market data expressed in correct financial terms

Good market data is difficult to obtain

Wide ranges around median with no explanation should be unacceptable

See #1 above
Fix the performance management process (no, really….) – financial professionals
allocate scarce resources

Execution of process

Differentiation in proportion to productivity (may be 5x to 10x, not +/- 20%)
Action Steps
Repeat after me: I am a marketing professional, I am a marketing professional
1.
2.
3.
Segment your labor market

Profitability of “customer” segments

ROI of attraction and retention expenditures
Understand the four Ps of marketing and where to allocate resources

Product (job, organization, culture)

Price (pay, opportunity)

Place (location, flexibility, technology)

Promotion (brand, recruiting, communication to employees)
Train recruiters and retainers in complex pay communications

Cash vs. equity vs. benefits vs. time vs. opportunity

Financial vs. nonfinancial value
Action Steps
Repeat after me: I am an HR professional, I am an HR professional..and still need to deal
with tactical issues
1.
2.
Develop a total compensation focus

Trade-offs among cash, equity, benefits are escalating

Total package valuation model

Integrated competitive intelligence, not element-by-element
Fix the performance management system

Allocation of increasingly scare resources requires significant differentiation
to ensure appropriate compensation for most valuable employees

Only uniformity should be where required (qualified plans) all other
programs should have wide ranges and high proportion of zeroes
Action Steps
Repeat after me: I am an HR professional, I am an HR professional..and still need to deal
with tactical issues
3.
Integrate talent management and compensation

Competitive intelligence system

P&L for every department’s total compensation expenditures with ROI
accountability

Linked into incentive compensation systems