How Does Principles-Based Compensation and Governance Work?
Principles-based executive compensation and corporate governance starts with the big picture: the principles that govern a corporation’s compensation programs and best express the board’s strategic intent in pay plans. Principles create a common language about compensation between the board and shareholders, between the board and management, and between management and employees.
Principles are broad enough to conjure great power, yet precise enough to communicate very specific meanings that inform and support both strategy and tactics. As a result, principles give broader understanding of compensation, providing a thorough and consistent conceptual framework for making tough decisions, designing incentive plans, and creating optimal alignment.
How does The Delves Group put principles-based compensation in place?
The Delves Group starts with an assessment using the Independent Directors Executive Compensation (IDEC) project executive compensation principles: Alignment, Accountability, Engagement, Fairness, Objectivity, and Transparency. We then work with the Board and Management to customize these principles to reflect the Company’s culture and values. Once the principles are set and defined, we conduct a thorough analysis of all the Company’s compensation programs, which allows us to draw out significant themes, conclusions and areas of improvement.
We have found that our clients, like Best Buy Co., gain more clarity of Board intent after a presentation of principles than with only a traditional compensation study. We have also found that Management provides greater strategic insight and depth, leading to better plan design from HR.
What kind of questions does principles-based compensation and governance help us answer?
Most discussions about executive pay stop at how much a specific individual or group of individuals earn in the coming fiscal year in direct salary and stock options. But how should a company motivate top executives to be creative and diligent when the company’s stock price (and thus the value of his own stock options plan) is falling during a hard recession, like the one we face now?
Conversely, how does a firm motivate an executive to watch out for risks or a changing marketplace, to look for new product ideas or business opportunities, and to be prepared for new technologies that might change or challenge the company’s business model, even when the profits are strong and the stock value is rising?
And how should a company design a compensation plan to show the primary stockholders that the firm has their interests at heart, to motivate all of the employees in the firm toward creative, disciplined effort, and to create a message for the public and the media that shows that the company is interested in being a respected, honorable corporate citizen? These are the kinds of conversations that The Delves Group principles-based compensation services are designed to promote.
What is IDEC?
The Independent Directors Executive Compensation (IDEC) Project is a collective effort to create executive compensation principles that independent directors and boards can voluntarily adopt. The Project is an outgrowth of the great concern over compensation governance felt by independent directors, academics, and executive compensation experts.
IDEC’s originated from a series of small group meetings and individual conversations starting in 2009 and held throughout the United States. These gatherings and discussions have involved nearly 200 directors and professionals. Those who participated have agreed on the following points:
- There is a serious problem with executive compensation in U.S. publicly traded companies.
- Independent directors should take the lead in addressing this issue.
- An independent body should be formed to research, develop, define and communicate a continually evolving set of principles and best practices.
- Those principles and best practices should emerge primarily from a series of meetings and conversations with small groups of independent directors.
What does principles-based compensation do for an organization?
In its experience helping Boards implement principles-based compensation, The Delves Group has found that principles-based executive compensation allows a board to achieve better strategic alignment throughout an entire organization. At one Fortune 50 corporation, the compensation principles adopted by the board and management gave HR the tools and guidance it needed to design the most comprehensive and cohesive compensation program it had ever done.
The program fit with the company’s mission, the board’s strategy, and the overall philosophy of how this company grows and creates value. It’s aligned with shareholder interests and management priorities and has exceptional payouts for exceptional performance.
How do the same principles work in different organizations?
Different organizations interpret the same principles to express different strategies and incentives. They find meaning in the principles that express their unique personalities, purposes, and strategies. And they develop very different compensation plans based on those differences in interpretation.
The Delves Group also finds that it must develop custom principles for organizations to meet needs that are not encompassed by the IDEC or other standard compensation principles. Again, the interpretation and definition of principles is done by the Board to express its intent and strategy for the organization and how it performs for the constituencies it represents.
What are the theories behind principles-based compensation?
The Delves Group bases its work with principles-based executive compensation and corporate governance on 20 years of practical principles-based leadership training and research at the Wright Leadership Institute. We also draw on agency theory, which examines the relationship between the principal (the shareholders) and the agent (the CEO)—who has been engaged to make decisions on the principal’s behalf.
For details, read Agency Theory Summary, a scholarly review of the evolution of this theory and the ideas that underpin it by Don Delves and Brian Patrick. Additional papers appear on the Agency Theory page.
Are there other organizations developing principles for executive compensation?
Yes. The IDEC principles were built on and encompass the work of organizations that are in the process of designing compensation principles or have already implemented them appear on the IDEC “Corporate Governance and Executive Compensation Principles” page.
