Director's Toolbox: Rewards

The field of knowledge board members need to understand has grown sharply in today’s global economy and constant tech disruptions. This regular series explores many of those key topics.

What are ‘rewards’ and why should a board care?

Rewards are the entire package of incentives that motivate executives to bring their best to the job and build value for the benefit of the company and its shareholders. That includes salary, cash bonuses, and stock awards, of course, but it can also include intangibles such as “meaningful” work. Building a package of rewards that inspires a talented CEO to take the job and stay on at the company is of course the board’s primary role. The board also must, through its oversight duties and the work of the compensation committee, ensure that rewards fitting the company’s culture also flow fairly through the entire organization.

“The first level of rewards is really about ‘caring and feeding,’” says Jean-Marc Laouchez, senior client partner and president of the Korn Ferry Institute. “Executives need to get paid like any other employee. But there is another level of incentives. It revolves around the idea, ‘What can we offer that will inspire executives to bring that extra energy and go beyond the expected?’”

How are rewards determined?

There are generally two components to rewards packages. Financial compensation is often determined by benchmarking a CEO’s duties with the pay within the company and the pay in the firm’s industry at large. Boards should then tweak a package for an executive’s particular skills and value they are expected to bring to the company. Other incentives—such as corporate support for a favorite philanthropic cause or benefits supporting a wholesome work-life balance—are tailored to the individual executive.

A large study published by Harvard Business Review in 2017 found some surprising correlations—or lack thereof—between pay structures, employee motivation and corporate performance. The study found that pay incentives tied to an executive’s performance were “positively associated with job satisfaction.” However, bonuses tied to corporate-wide profits generally made employees less committed to their jobs and more inclined to bad-mouth management. Why? An executive who delivered the goods is demoralized when his or her bonus is slashed because poorly run divisions elsewhere damaged the firm’s overall profitability. Indeed, another study poled 1,000 U.S. employees and discovered that 20% preferred a promotion and better title to a pay raise below 3%.

Laouchez cautions boards against following such studies blindly and says rewards always need to serve a company’s culture. “If the company is decentralized, with units operating autonomously, then it’s appropriate to reward each team according to their results,” he says. “But where it is important to have a collaborative culture, with units helping each other to earn additional business for the company, then compensation should be tied to a firm’s overall profits.”

What should boards look out for?

In 2012, shareholders sued a major bank’s board for overpaying its CEO, whose leadership saw the bank’s stock performance lag behind peers. University of California, Los Angeles law professor Steven Bank says such shareholder lawsuits rarely win against public boards. Activist shareholders who take large stakes and then have a dialogue with the board and other investors are the most effective levers to curb excessive pay, he says. Still, politicians and the public are increasingly outraged by CEO pay far in excess of their employees’ wages, and a 2018 SEC rule now requires companies disclose such pay ratios. (See a related interview with Amazon director Thomas Ryder and his take on pay.) In this highly charged environment, boards have an acute responsibility to offer talent competitive packages without being overgenerous.

The most attractive rewards, experts say, are tailored to the individual and don’t have to cost lots of dollars. For example, giving a CEO candidate a challenging assignment that will force them to grow doesn’t cost extra but is a big draw to take the job. Similarly, knowing what a CEO candidate’s favorite causes are and allowing them to have even more impact in those fields, also adds purpose and meaning to the position. As a Korn Ferry report on managing talent points out, “everyone deviates from the average,” which is why savvy boards find out what a prospective CEO uniquely values and uses that knowledge to get the most out of the executive.