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For those who have been away there is a significant change taking place in the workforce that you may have missed. A generational transition is underway introducing new values to the workplace creating a seismic shift in culture and the way in which employers are interacting with their employees. Compensation, traditionally existing in a vacuum and in parallel to organizational development, can no longer be excluded from the tools available to strengthen culture and engagement:
The Millennial Apocalypse
The most significant generational influence and the largest cohort in the workplace is testing the policies and practices of all employers, including even tech startups. The response however is not as simple as defining separate HR policies for younger employees.
The values that they exhibit are being adopted by older workers and exposing legacy policies to be inadequate. Workforces are like ecosystems; they morph and change over time, with their predominant values reflecting their demographic makeup and leadership. There are 10 years or so left before the last Boomers head for the exit (that is assuming they don’t discover that socialized healthcare is not really what its name implies, requiring them to have to work a little longer!).
Of all the positive attributes brought by this cohort to the talent pool, wisdom and experience are not on the list. And employers, while learning to connect with these new personalities, are at the same time having to maintain the enthusiasm of an older cohort with one foot out the door, suffering from the unwanted attention of the new guy who can’t wait to get their job.
A Shrinking Talent Pool
In the future there are going to be fewer people to choose from. In absolute terms the numbers available in the talent pool will shrink but as employers work to build engagement they will take fewer risks with people they believe are going to disrupt the harmony of the workplace. They will be more selective about who makes it into the team. One bad apple could spoil a culture and cause a decline in productivity. Fewer people available and fewer still with the attributes to fit the culture.
Employers are therefore going to work harder to keep and develop the employees that they have but the traditional list of retention tools is shrinking and/or becoming less effective. Defined benefit pension plans worked fine with boomers whose objective was to stick it out to retirement. Younger folks see no advantage and in fact will regard tenure weighted savings plans as a dishonest offering when after 3 or 4 years (when they intend to quit) there is little or no benefit accrued. Recruiters will be suggesting to candidates that any longer than that in a job and prospective employers will start to wonder what’s wrong with them. Remaining employee benefits are likely to uncouple from employers and cease to be retentive and with salary inflation so low, little cash is available for retention incentives. Further and as we discuss later, deferred equity awards may cease to be appropriate for this purpose too. Employers are going to have to work harder to create workplaces that their employees enjoy and that keep them showing up.
Technology
Any discussion of the workplace cannot escape reference to the effects of technology. Needless to say it will be relentless with developments both dramatic and measured. Workplaces are never fully prepared for change but with greater numbers of young people immersed in technological change individuals will be more accepting and less threatened by its introduction than their predecessors. There will not be the quantum leaps in required training or resistance to dramatically new methods that we saw with a workforce educated and trained in an analogue world.
Those who grappled with the introduction of ERPs will know that the headcount savings never materialized and workers threatened with displacement simply moved on to new work created by the better insight and data resulting from the new system that we now had at our disposal. We became more sophisticated in our analysis and research and more employees were needed for this task. That will continue, technology will allow incremental business change as greater product or customer knowledge becomes available. A workforce will need to be ready for constancy of change from technological application. However, the success of its adoption will mean keeping pace with the experience that employees enjoy as consumers. Workplace applications will need to capture the same design thinking as personal phones and other consumer devices – if I can do it on my phone it should be available in my work. Design thinking in the workplace has not kept pace with the consumer world.
…AND THE IMPACT ON PAY?
At this point you could be forgiven for wondering what all of this has to do with pay. Pay policy is about ensuring we are matching the market and at the executive level, that we are compliant with regulatory and advisory guidance, right? Well that’s how it used to be and for most employers still is. Compensation is managed largely separate from business strategy and leadership systems. Even employers with self described “unique” business driven reward structures still tend to fall back on the ARM doctrine; Attract, Retain, Motivate.
The balance of this article discusses the inadequacy of this way of thinking as we attempt to successfully weather the imminent storm and why this may not be the best doctrine for establishing contemporary pay philosophy going forward.
Competitive advantage means differentiation; through a product, process, design or some other distinguishing feature that leads to a unique business strategy that differentiates an enterprise from its competitors. It has always been thus and no matter what that distinguishing feature might be it will not be able to be fully optimized without the company’s employees engaged to achieve it. The primary organizational connection is the one that binds companies to their customers which ultimately is the primary source of profit. Fulfilled, happy employees matter because, without them, guess what no happy customers.
As human capital becomes scarcer and employers more discerning about whom they permit to join their team leadership will become critical, and reward cannot be excluded from leadership’s tool box. Alongside all of the other devices at the disposal of supervisors to maintain and enhance engagement there needs to be pay.
Talent management is increasingly focused on the individual with development activity and performance feedback customized to promote and motivate engagement and achievement of the organization’s goals -compensation has not yet received the same treatment.
Compensation customized by individual is not generally welcomed in fact it is discouraged, perceived as high risk and associated with concerns about high administrative cost or poorly managed goals resulting in the payment of awards out of proportion to performance. These are considerations that mask the greater opportunity for longer term value creation that will be lost if talent management and pay are not aligned for sustainable differentiation.
ATTRACT, RETAIN AND MOTIVATE
Consequently the pay philosophy typically espoused by employers no matter what size, industry, or geography is that reward should “attract, retain, and motivate (ARM)” which appeals primarily to base human needs rather than driving competitive advantage. This will need to change if an organization is to remain viable in the new world.
Compensation programs may attract some employees but a myriad of other considerations will inform the decision of a potential recruit to join a prospective employer. A minimum expectation will be that pay is broadly competitive but it will by no means be the determining or most important factor. There is no reason why it should be with the amount of survey data and disclosure tools available to potential recruits and employers alike – it will be taken as given. With low salary inflation over the last ten years there is far less differentiation in pay and greater homogeneity. Where significant pay disparity does exist it is likely to be minor and temporary.
If there is a part of the pay program that holds the opportunity to be attractive it may be incentives; how they are designed and distributed rather than the amount on offer. Similarly whether pay is managed transparently and equitably will be influencing factors for new young recruits. At least for the time being new employees are less driven by the need for higher compensation than their predecessors were and are more concerned with the manner in which it is managed.
Compensation is often quoted as the reason for leaving an employer but is code for one of a myriad of other real reasons behind a departure. ARM favors preservation of current state and does not focus on sustained corporate differentiation. Companies wedded exclusively to an ARM mentality run the risk of stagnating. Attract and retain translates, simply put into making sure that pay is at the market and that will fix any attract and retain problems. This philosophy might have been adequate in the past and still may be in some industries for unskilled employees but it will be increasingly ineffective as organizations strive to secure gains in productivity through improved engagement.
The longevity of an organization is dependent upon staying ahead of competitors and sustaining a competitive advantage. Encouraging innovation and creativity is therefore a crucial feature of a successful culture and companies are coming to realize that this is achieved through motivating engaged employees to advance company strategy. Changing workplace values are causing deep examination of the role that pay can play in this endeavor. For example we recently worked with an employer in Spain to develop a collaborative incentive plan to encourage two teams to develop a better transition in the process that they were both involved with at different stages. A proportion of generated savings would be shared amongst team members – not unlike gain sharing plans that were popular in the seventies and eighties.
Effective compensation must be wedded to the culture of the enterprise and those seeking an engaged workforce will strive for programs that reflect internal values of fairness, collaboration, and transparency. These will carry as much weight in compensation policy as external benchmarking.
A WRITTEN PAY POLICY
An organization’s compensation philosophy must include the company’s values and highlight how they are embedded in pay policy and be documented in clear unambiguous language available to all employees. No longer will values be represented solely by that artistic plaque hanging in reception.
A company may publish employee salaries but if individual salary adjustments are determined through criteria that is never discussed then it will work against engagement. Making employee bonus decisions without disclosing how will have a similar effect. Awards without a clear rationale or perceived not to align with company goals and values are likely to have a negative impact with younger employees.
Disclosure of pay grade and salary ranges will not be helpful when derived through a job evaluation black box. While employees might know their salary ranges this will count for nothing if their manager cannot explain the rationale for where their role is placed in the pay grade hierarchy.
Companies should consider whether their JE system allows them to appropriately value jobs in accordance with their importance to the business and its strategy. For example skills that will contribute to differentiation might be valued more highly than generic ones. Does the JE system provide the flexibility to do this? The big proprietary JE systems may not.
Of course there are elements of pay that even in the most transparent environments should be confidential. Employees will connect the dots when an employer does not or cannot because they can’t explain or cannot remember the rationale for a component of pay policy. Secrecy will undermine efforts to be transparent and cause employees to be hesitant about trusting any shared information. Keep those parts private that should but clearly explain why. Everything else needs a transparent rationale. By the way “Trust me – we know what’s best” and “That is the Policy” are not probably not going to be sufficient for this purpose.
How an organization values work is critical to the perception of fairness. In fact big complex JE systems may not be perceived by employees as being sensitive enough to reflect the unique values of a company and thereby attribute compensatory recognition.
Elliot Jacques, the Canadian psychoanalyst and organizational psychologist, known for developing the notion of requisite organization from his ‘stratified systems theory’, which ran counter to many others in the field of organizational development, first articulated the concept of “Felt Fair Pay” long before engagement became the goal of organizations. Engagement is code for “happiness” and employers have known since the days of the Romans that happier employees were more productive employees (HR came up with the more professional sounding “engagement” some years ago). In a nutshell “Felt Fair Pay” posits that employees have an innate sense of what is a “fair” level of pay for the work being undertaken. Multiple research studies conducted at different periods have confirmed a direct link between what between employees consider fair pay and the “time horizon” of work within an empirically defined structure (i.e. a pay scale). Jacques captures this theory in the Requisite Organization which if I recall correctly runs to around four hundred pages in which the discussion of compensation takes up about four of them suggesting that if you get everything else right pay will take care of itself.
Felt fair pay does not appear to be in evidence in the current debate over CEO pay. Tax penalties, media pressure, shareholder “Say on Pay” and relationship disclosure have all been unable to temper the rate of increase. A leader enjoying compensation that the wider community view as egregious has to be a negative factor for an otherwise engaged workforce. Organizations that are serious about capturing the added value from engagement could do worse than having employees through a companywide vote set their CEO’s pay. That may just resolve the problem (and that more widely perceived by society).
THE BRUTAL REALITY
But of course the goal of long term competitive differentiation has to be balanced with the drive for improved short term shareholder earnings which determines how successful a company is perceived to be and often dictates the tenure of its CEO. The natural consequence of shorter CEO tenure is of course higher pay.
These goals can work against each other; shareholder value is a virtue when trying to attract investment but can be short lived if management is incented to hobble future performance through cost-cutting and downsizing? A sustainable organization must constantly be seeking ways to maintain its competitive advantage and without the appropriate motivation that goal will not be achieved. This becomes a nail in the coffin of engagement as employees will perceive a major disconnect in the values chain if an organisation’s stated goal is conflicted by quarterly results.
Executive pay philosophy at most companies whether they realize it or not is is influenced by the so called “Principal – Agent Problem” which describes the challenge of motivating executives or employees (“agents”) to act in the best interest of the company rather than themselves. For example how can a client be sure that her lawyer is acting in her best interest when an alternate approach may generate more fees for the lawyer? This concern stems from executives having a more detailed level of information and knowledge about the company’s capability. Shareholder response has been to place executives in the same position as owners and to be compensated in part through improvements in equity.
Lower down in the organization incentive thinking has evolved over time arguably with changing boomer values from the militaristic style of “Do this because I’m your boss and I say so” through “Do this in exchange for pay” and more currently where contemporary incentives are being built around common values “You care about this and so do we”.
Applying these models to motivate outcomes was an important function of management. Knowing when to apply them and facilitating outcomes is leadership. No longer will job descriptions be just a list of tasks to be completed by the incumbent but will now need to include and allocate time for coaching subordinates through their individual activities and inspiring behaviors that support the company’s strategy. Employers need to be working on inspirational leadership training and development of the appropriate, supporting incentives. Management’s future knowledge gap won’t be information but its inability to inspire success from a workforce comprising more educated and more technology savvy folks who are less resistant to change, and older employees with wisdom and experience who resent the new upstarts who want their jobs.
Compensation customization runs counter to traditional views of shareholder interest but if sustained differentiation is a strategic goal of the company then continuous innovation is what should be incentivized. Employees should be asked to contribute their thoughts and recommendations to incentive design and similar to the experience with other HR policies their effectiveness will improve. For example collaborative incentives may be considered more motivational than the traditional individual goals preferred by boomers. These may occur where there is a particular bottle neck and management is not close enough to identify an effective resolution. Those most affected are asked to collaborate and are incentivized to resolve the problem. Alternatively it could be where a process transitions from one phase to the next and colleagues are incentivized to effect a more efficient transition by assisting each other or it could mean working together to take discernible steps to avoid workplace accidents. If an organization values autonomy and self responsibility then choice might a logical feature of an incentive plan both in how goals are to be achieved and in how payouts are to be made.
Leaders struggled with no longer being able to manage facetime when employees began to work from home so they will also have to let go of the need to micro manage delegated tasks and trust employees to act autonomously in pursuit of the company’s goals. At Netflix for example the travel and entertainment policy is “act in the best interests of the company”.
PRINCIPLES AND AGENTS
Millennial employees will prove to be similar in their aspirations to any other generation – they are after all human – and will look for purpose in their work and to be paid proportionately to the value that they add. Like prior generations they will want to progress through the organization but unlike their predecessors they are likely to tell you directly that that is what they want. They will expect and respect an honest explanation of why their employer cannot deliver that aspiration at least in the short term. Transparency, authenticity, and alignment are the values that will be expected to be honored by younger folks and that will begin to be adopted by their older cohorts . Compensation cannot be exempted from this scrutiny.
Baby Boomers and Gen X employees have much to impart to the new workplace. Employees have access to unlimited information and assume that the answer to anything can be looked up online. They won’t appreciate the distinction between having “information” and “understanding” it. Compensation incentives can be an effective method of bringing different groups in the workforce together such as age cohorts and, permanent and contract employees by motivating them to collaborate to achieve effective solutions.
Placing executives in the same position as shareholders was thought to be an important motivational tool while simultaneously mitigating the concerns associated with Principal and Agent. Consequently incentives began to be delivered in the form of stock or units harnessed to the stock’s performance in the market and have now became the norm for executives.
The allocation of equity to insiders diminishes its impact but avoids having to dedicate precious cash to compensation. The counter is that the complexities and associated administration involved with equity as a compensation incentive have a significant cost and has spawned an industry that monitors market comparison and legislative compliance. Often deferred for several years awards are distanced from the performance event that they are intended to reward and are subject to the volatility of the market over that period which may or may not be the result of executive activities.
Let’s say that a company creates a unique product enhancement in its primary business that may not impact share price for some years and rewards those responsible with a deferred award that is exposed to the external market for the company’s shares before the proceeds are received. Thus alignment is achieved but it ignores the impact of taxation between deferred compensation and the shareholder’s investment. Incentive awards that fall closest to the performance event are likely to be more appreciated and consequently have a greater impact on engagement. Exposing the award to the vagaries of the financial market will further potentially dilute its impact.
When Jeff Immelt announced that he was stepping down from the CEO’s role at GE Jack Brennan, the lead independent director in tribute said that his work at GE would benefit investors and employees in the years to come…..Has Mr. Immelt already been compensated for those activities or is his compensation going to track that benefit after he has left the company?
Putting capital into a business requires an investment decision concerning the associated degree of risk. Employment contracts already carry risk of a different type and when equity granted as compensation is added to the mix it involves an additional degree of exposure.
Engagement rooted plans involve risk directly related to task, the successful completion of which involves the application of an individual’s skills resulting in an award unfettered by extraneous factors. Will future workforces be motivated by the value proposition behind equity compensation; concerns about agency issues, insufficient cash and deferral? Particularly when they consider the constraints attaching to equity awards by legislative compliance and tax rules which separate compensation from the company’s differentiating strategy. Might they also conclude that equity compensation is the cause of the great debate over CEO pay?
Boomers valued loyalty and felt obligated to stand or fall alongside shareholders and besides, stock options were a sign you had made it and signaled a degree of status – it was macho to be a shareholder. Equity compensation awards aligned with boomer employment tenure expectations but this may not appeal to younger executives who perceive work not as a career but as a commodity with a shorter shelf life.
Largely in response to Principal/Agent concerns shareholders want to see that executives have significant personal holdings in the company’s stock when proxy disclosures are released. Maybe that will change too as shareholders become younger and are less concerned about executives bearing greater risk than themselves but until then why not consider separating investment and compensation decisions and providing employees with a stock purchase plan perhaps with a discount, that enables accumulation of the desired level of holdings but distinct from incentive compensation.
BEING AVERAGE
Shareholders take comfort from homogeneity and their company conforming to group norms in the belief that this reduces their risk. Shareholder advisory groups and executive compensation consultants exist to serve this need advising boards acting on behalf of shareholders on “governance” and “best practice” with regard to equity compensation. Such examination has to be based on past practice as a guide to the future and the process of surveying peers encourages companies to follow median behavior which inevitably engenders over time average performance. More importantly boards through this practice are encouraged to behave homogeneously rather than in a manner that supports differentiation and the sustainability of a business.
An illustration of this thinking is a director education program on executive compensation for new directors that we recently came across where the curriculum was focused on governance and did not once refer to the importance of strategy. One of the most common criticisms of new directors by Board Chairs is that they come overburdened with compliance considerations and not enough practical education. Pay philosophy structured around engagement and sustainable differentiation will likely not align with contemporary governance expectations but will prove the best long term path to superior performance so why not uncouple it from added complication.
Retention appears before motivate in the ARM acronym (perhaps to improve its appeal as an acronym?) but maybe also, inadvertently affecting how companies think about it as a priority (i.e. suggesting that retention is more important than motivation). Clearly this is wrong from the perspective of business performance. Attract, Motivate and then Retain better describes the objective but AMatR doesn’t roll off of the tongue half as well.
Retention by itself does nothing to encourage contribution. Traditionalists would argue that retention awards motivate behavior but the high performing individuals who they select for such recognition are already motivated (otherwise why would they be performing at such high levels) and emphasis should be on encouraging the continuation and expansion of that motivation and not just on encouraging good employees to stick around.
The conventional list of retention devices that companies turn to is rapidly diminishing; low levels of salary inflation have essentially taken cash off of the list, pension and benefits are diminishing in their effectiveness. A slug of deferred equity may be simple and appealing but it is not adding value per se and in a perverse way as we have seen may work against the principles of an engaged employee who may perceive it as disingenuous. As the labor pool thins and employers become more selective in attempting to secure qualified talent, sustainable retention will not come from the traditional go to list but from a positive workplace culture based on common values and goals that is constantly striving to improve – one where people want to come to work. Get that right and retention will cease to be a problem. Relying on compensation with a three-year horizon dictated by tax rules and exposed to external influence may not prove adequate whereas a differently framed discussion about the envisaged earnings over the expected employment tenure in exchange for an agreed contribution may well be.
Human capital is a competitive advantage and to unlock hidden potential and opportunity consider rethinking the “attract and retain” mindset. Consider the adoption of customized compensation philosophies embedded in engagement that drives longer term shareholder value.