1.
Introduction
Designing
manager’s compensation schemes
is one of the most important, most specialized and
challenging tasks for human recourse manager. Managers are
“one of kind” individuals, who are hired to take some responsibility
of leading or directing the whole organization or a project.
Their decisions are pivotal in developing overall organizational
objectives, policies and business strategies, poor decision
may lead to negative consequences for entire organization.
Nowadays it’s became common sense, when managers are rewarded
not only by salaries, retirement and health benefits, but
also company’s shares and stock options. In this respect
complexity of manager’s compensation schemes appears in
two dimensions:
-
content of compensation scheme and it’s
value;
-
defining performance and the time frame
used for reward distribution.
While
the first dimension will be discussed later and in this
project, the second must be discussed now. Paying for short-term
performance gains, such as successfully finished project
or reached monthly profit, may neglect long-term performance, such as company’s
strategic goals or a particular brand’s market share. But it is also questionable logic
to make manager wholly or even partially accountable for
the firm’s performance because it depends on many factors
that are beyond the manager’s control.
For example, if a head of Strategic Business Unit
of a certain organization is risk averse person, who receives
basic compensation packet plus some percentage of profits,
suddenly begins receiving only percentage of profit as a
salary, the SBU’s stability will be questioned. We can distinguish
two outcomes in this situation: either this person would
feel completely uncomfortable (as a risk averse person)
and soon will leave the company, or he would lose control
at the economical/market situation and will make wrong decisions.
Both these outcomes are negative for a company and may be
possible when a manager became completely responsible for
the company’s performance.
Companies may also have different approaches to manager’s
work compensation in regard to the level of autonomy, associated
with the phase of organization’s growth[5]. Division manager
in firm, entering Phase 3, generally experience more autonomy
than do his colleague in firm, being in Phase 2, or entering
Phase 4, where he has both much responsibility and necessity
to “justify actions to a “watchdog” audience at headquarters”
[5]. As a consequence, he is better able to link rewards
(bonuses, compensations packages) to own performance.
There are many alternative theories, which suggest
different approaches to this problem. For example, Deckop
[4] argue, that manager’s performance should be evaluated
on global factors, such as “internal leadership”, “dealing
with various constituent groups outside the firm”. Steers
[3] agrees with this, but concludes also that political
factors are more important in setting manager’s pay than
“bottom line” performance measures.
This
and all other problems, which appear when company designs
and implements managers’
compensation schemes, are avoided if the compensation system
is integrated into overall business strategy. It means that
organization must develop strategies to achieve its ultimate
goals and in this process it establishes programs and activities
to accomplish them. Many supporting systems help organization
achieve its objectives, compensation is one of them, along
with marketing, finance, production and other functions.
Firm can not be successful in its management compensation
strategies over the
long term, unless
they are coordinated with other organizational subsystems
and designed to reinforce the strategy adopted by the entire
organization.
Changes in the business environment are making it
necessary for firms to create new and review old approaches
in management compensation
schemes. For example, it will be illustrated later, how
changed perception of stock option schemes from 60’s to
90’s, and which trends in this phenomenon exist now.
2.
The role of politics in manager’s compensation.
Mintzberg
[6] suggests that managers spend considerable time acting
as political figures in their organizations. In this respect,
their work may be described as managing internal coalitions
and transactions between these coalitions and external constituencies;
one of the most important goals in their political games
is to obtain adequate compensation package. Among reasons
for this are following:
-
to receive external confirmation of own
importance, qualification, experience, leadership ability;
-
to be able participate in overall company ‘s decision
making (in case of rewarding by company’s shares), or at
least , to feel close relation to company;
-
to accompany legitimate and illegitimate
systems of influence, obtained in an organization: place
in organizational hierarchy, ability to make decisions and
implement changes.
I would
like to underline two types of power games: Expertise and
Budgeting, because they are the most relevant in this project.
They both based on knowledge, education, work experience,
and even uniqueness of a player. The small difference is
in goals. If an expert’s explicit goal is compensation package
and work conditions, for line manager, it is also status in an organization.
“Darwinian” function role of politics [6] for a line manager
is very important, because he must ensure stability of own
leadership position in eyes of subordinates and supervisors.
This stability is reached partly by designing sound compensation
package. For example, giving a stock option, which can not
be exercised for 10 years, but nevertheless, has a solid
market value, may demonstrate
to a manager- company’s care about him, and to manager’s
subordinates- his importance, level of authority and value
in organization.
Mintzberg
[6] gives also detailed characteristics of
other related to this project games: Sponsorship,
Alliance Building, Empire Building, Strategic Candidates. Except that they are coexistent with legitimate systems of power, all of them
(and other, not mentioned here, too) have other common feature:
receiving adequate reward for invested in company knowledge,
education, skills, time and efforts.
It
is possible to mention also Centralization power game by
top managers, but issue of rewarding top executives is rather
different than one of ordinary
managers, because of their much bigger influence and status.
In the context of politics, top executives, serve as symbolic
figures and political
strategists at their organizations, who manage both internal
and external political coalitions. Most obvious example are
maneuverings that characterize mergers and acquisitions.
In terms of compensations these political and symbolic activities
are difficult to evaluate. They are not always clear, and
criteria for evaluating success in these activities are
often ambiguous.
In regard to the trends in manager’s compensation
schemes, I would like also mention changes in external environment:
increasing importance of institutional investors, global competition,
creating knowledge economy, global presence of informational
technologies, etc. These changes lead to shifts in internal
and external power configurations, and as a consequence,
redesigning the whole system of job compensation, could it be salary, health
insurance, or retirement benefits.
3.
Overview of manager’s compensation schemes.
Formal bonus or incentive plans are common and popular and most effective [7]. These plans are typically
available for upper management employees although participation
in the plans is widening, especially as organizations remove
layers of management (Phase 5, [5]). The target formal bonus
award is about 25-50% of the managers' base salary.
The size of the award is usually based on a combination
of the participant's individual job performance, the business
performance of the participant's division or department,
and/or the performance of the entire company. Typical performance
criteria includes profit before tax or operating profit,
sales level or sales growth, and/or the achievement of specific
company or division goals.
Profit sharing plans
are funded by the organization's profits based on a specified
formula. The profit sharing pool is then allocated to managers
as a percentage of their base salary, typically 5-6%. Currently
approximately 40% of companies offer profit sharing plans.
A typical profit sharing award is 5% to 6% of manager's
base salary.
Spot bonuses (a) and Lump sum merit awards (b), perks provide recognition for an individual's
work accomplishments, which are paid immediately after a
significant job performance event (a) or as a part of the
annual salary review process (b).
Stock plans are very popular. A mystique surrounds them, perhaps because a few
people have gotten rich from stock options.[7] Virtually
all companies offer some type of stock plan to employees.
Stock option plan
is a most common form of stock
plan. Manager is offered a specific number of shares
which he can exercise (buy) at some specified time in the
future. The price at which he can buy the stock is equal
to the market price at the time the stock option was granted
(grant price). The employee's gain is equal to the market
value of the stock at the time it is exercised, less the
grant price. If the market price of the stock remains the
same or decreases relative to the grant price, then the
stock option is worthless.
Stock options provide companies with a long term
incentive and retention tool. The recipients of stock options
are motivated to help the company perform well, so the stock
will appreciate in value. Because they must wait several
years to receive the entire stock option grant, managers
are motivated to remain with the company, as long as the
stock value is increasing.
Employee stock
purchase plan is typically
available to all managers in the company. They can purchase
company stock through payroll deductions (typically up to
10% of pay) at a price that is below the market price (typically
85% of market price).
Pension
plans, Health and welfare plans
offered to all fulltime employees and typically cost organizations
12% to 15% of payroll.
Variable compensation
is based on the number of specified skills, qualifications
or tasks manager has mastered.
4.
Trends in manager’s compensation schemes.
Over the period 1997 to 2002, total manager’s compensation
increased by 15 percent.
The most recent findings have revealed the trend
towards higher salaries for top executives. [8] The recession is claimed to be the reason for
mass loss at stock options, burned by the market;
managers aren't accepting the changes without protest, beginning to demand more tangible rewards such
as cash, bigger bonuses and material perks to offset the
risk of options [9]. So, trends in management compensation
can investigated in two dimensions: cash and non-cash.
4.1.
Non-cash, or stock compensation schemes.
Stock options were practically irrelevant during
60s and 70s, when share appreciation was almost null. Managers
with worthless options laughingly called them “wallpaper.”
The situation began to change with the emergence of the
computer industry. Managers took big options grants in lieu of big salaries
when they joined IT start-ups such as Oracle Corp., Sun
Microsystems, Microsoft. When the companies went public,
“the computer prodigies who had cast their lots with them
were rich - and the stock option's central place in the
industry was cemented.” [8]
For companies, options grants are free money, because
in their accounting treatment they are doubly blessed: They
aren't declared as a cost on corporate earnings statements,
yet they are deductible as a cost for the purpose of taxes.
Of course, there is no “free lunch” and
not every manager can pretend to have stock options. For example, about 30% of Microsoft Corp.'s work
force is classified as “temporary,” ( not fulltime)
and thus ineligible for stock options - even though one
may work, say as program manager,
at the software giant for years.
Many companies are finding today,
that a regular options program isn't enough to retain
the best managers and are turning to “special stock options”.
The term refers to extra options, often called chairman's
awards, that companies grant to certain standout managers
whose compensation packages already include stock options.
This isn't a case of just raising an employee's regular
grant under a company's options program. These are special
one-time awards of options to reward specific achievements
by an employee or to retain a valuable manager who is at
risk of leaving. Sometimes these additional options even
have longer vesting periods (the length of time before they
can be exercised) in order to further entice manager to
stay. That's because
many companies are under intense pressure to provide incentives
to key managers- such as information-technology staff and
development engineers- who are getting bombarded with job
offers. Some compensation experts say they're now advising
companies to set aside as much as 5% to 10% of their stock-option
pool for such special bonuses.[7]
To maximize their retention power, companies might
award a special grant of options for, say, 100 to 2,000
shares. And they might be fully exercisable after five years,
compared with the typical three-year or four-year vesting
period of regular stock options. Some companies have created
special bonus programs for employees considered high-risk
or particularly valuable. Under such a program, a company
might from time to time award special options or restricted
stock to key managers
who have the potential to move up the ladder.
For example, American Express Co. counts its special-options
program as one of its successful initiatives. Each year,
company awards regular stock options to middle and
senior managers based on a list of criteria, such as an
individual's contribution and the company's overall performance.
In addition, “we have the flexibility to award special grants,
if we believe that awarding options to attract and retain
key talent would be helpful, we can do that.” [10]
Typically, companies are very quiet about awarding
such special bonuses to avoid creating envy among co-workers.
Whereas all employees would be aware that coworkers receive
options under a company's regular option program, they wouldn't
necessarily know when one manager is singled out for a grant
of special options.
The recent recession, however,
created necessity to go back to cash compensation:
with decreasing of P/E
ratios from infinity (for internet companies) to, say 10,
options are going to look less valuable.
4.2.
Cash compensation schemes.
For
the first time since 1985, there has been an overall decrease
in the benchmark salary paid for managers virtually in all
industries. Senior staff levels have some good news; base
salary has inched up while total compensation has gone down.
As the economy worsens, mid-sized organizations are effected
more and thus are cutting costs and staff faster. “Many
larger organizations have put hiring freezes in to effect
as well as stretching out the time period between normal
compensation increases. In the past six months there has
been a significant "thinning" of the layers within
many organizations.” [11]. The chart below shows the seven
year historical trend of the benchmark ranges for the different
management positions in US organizations. [11]
In
post interviews, Janco found reduced corporate earnings,
which make up key components of most performance bonus plans,
have driven the trend to lower total compensation. There
has been a decrease in demand for IT professionals due to
extensive across the board head count reductions. In addition
as more companies have closed their doors, the surplus supply
of senior level IT professionals has exploded. A factor
not fully reflected in the study is the delayed effect of
9/11 and the move away from concentrated metro areas for
some IT and back office operations.
There are some bright
spots. The good news is that over-all productivity is up
in IT organization and demand is high for Disaster Recovery
and Security job titles.
Most of the decrease is
based on reductions in performance bonuses for the most
senior positions..
Biotechnology companies
are also increasing their use of vari-able compensation,
as a means of attracting quality candi-dates and managing
their compensation budgets. Variablecompensation is normally
closely tied to achievement or over-achievement of specific
corporate goals and objectives. Ifthese objectives are not
met, there is usually no payout to theindividual.Variable
compensation, traditionally only available to manage-ment
or sales positions, is now potentially a component of allpositions
in an organization. However, the percentage of vari-able
compensation in total compensation packages variesgreatly
among positions:· Senior management and sales positions
commonly have35 - 50% variable compensation in their total
compensationpackage· Technical positions have approximately
10 - 15%variable compensation· Administrative or support
positions have less than 5%variable compensationTotal Cash
Compensation levels being paid to key biotechnol-ogy positions
should be monitored as an indicator of the stateof the biotechnology
industry. Competition from the pharma-ceutical industry
is a key factor driving many biotechnologycompensation levels.
Compensation data for 2000/2001reports the following average
total cash compensation* paidout to a selection of biotechnology
positions:·Sr. Manufacturing Executive$133,700·National
Sales Manager$121,700·Business Development Director$111,500·Regulatory
Affairs Director$101,300·R&D Manager$98,200·Intellectual
Property Manager$92,500·Sr. Research Scientist$78,900·Sr.
Clinical Research Associate$70,500·Bioinformatics Software
Engineer $65,900*All figures national industry averages
in Canadian dollarsand do not include stock options
As we move from the economic
downturn of 2000- 2001, into a new year, uncertainty about
the magnitude and speed of a business recovery still prevails.
We don't have a crystal ball, but we are in the market everyday,
talking to business and IT leaders like yourselves.
Sources.
1.
David B. Balkin “New Perspectives on Compensation”
2.
Derek Torrington “Personnel Management”
3.
Richard M.Steers “Strategic Issues in Executive
Compensation Decisions”
4.
John R. Deckop “The Pay-for-Performance
Issue”.
5.
Larry E. Greiner “Evolution as Organizations
Grow”
6.
Henry Mintzberg “The Organization as Political
Arena”
7.
American Compensation Association
www.worldatwork.org
8.
www.forbes.com/investing/personal
finance.
9.
www.CareerJournal.com
10.
www.americanexpress.com
11.
www.e-janco.com/index.htm
12.
www.imercer.com
13.