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Equity Compensation Will Stop Short-Termism and Boost Growth

Offering equity compensation more liberally across all levels of a company hierarchy will promote long-term decision making; and is exactly what many of the world's most successful firms already do

Compensation is undoubtedly one of the most tried and tested ways to encourage the decisions and the work that lead to long-term growth but too many firms still get it wrong, and mainly because they let near-term targets get in the way.

For example, companies often use short-term incentives to motivate and retain talented managers, and use variance-focused operating reviews to gauge consistency over time.

But both of these approaches can inhibit a business’s ability to grow because managers become too focused on achieving bonuses based on quarterly targets, and so lose sight of the bigger picture.

Give them Shares, Not Bonuses

One cure for an overly short-term focus is to offer equity compensation more liberally across all levels of the organization. This has been adopted by many of the best performing firms of the past 20 years – firms that have grown revenue and earnings consistently over two decades (a group CEB labelled “efficient growth” firms). Incentives like equity compensation curb short-term thinking by increasing the stake employees have in the company’s long-term success.

“Perhaps the most effective tool we’ve used to quell [short-term thinking] is equity awards. Every full-time employee of the company receives equity every year,” the CFO at one of these handful of efficient growth firms told CEB. “So the division manager in Oklahoma City, he wants the best business decisions made even if we’re funding Pennsylvania or Louisiana, because he’s a shareholder,” he added.

In fact, analysis of 32 of the 42 US-based efficient growth companies against a control group shows that efficient growth companies use equity compensation more frequently, and give a larger portion of its value to non-executives (see charts 1, 2, and 3).


Chart 1: Equity compensation of efficient growth companies  Source: CEB analysis

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Chart 2: Total equity given to executive versus non-executive employees  Source: CEB analysis

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Chart 3: Change in equity granted from 2010 to 2015  Source: CEB analysis

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Time to Talk to HR

Armed with this knowledge, CFOs should talk with their compensation and HR teams about removing potentially harmful short-term targets in favor of long-term incentive schemes like equity compensation.

While equity compensation plans can be more difficult to design and require extra work to evaluate, efficient growth have used the philosophy behind them to grow their top- and bottom- lines simultaneously over the past 20 years, and have drastically outpaced their industry peers.

What’s more, simply optimizing the mix of compensation vehicles (long-term vs short-term incentives) can increase employee performance by 4%, according to separate CEB analysis. This small amount per employee will have a large impact on the organization over time.

Questions to Ask

Here are seven questions finance teams can use during conversations with their compensation colleagues to get started on this topic.

  1. What, historically, have been our intentions in granting equity in the past? Were we hoping to drive growth, retention, or something else?

  2. Have we made granting equity outside of the executive suite a priority, a side-thought, or an after-thought?

  3. How would our current compensation packages have to change in order to redesign our equity compensation policy?

  4. Who would be responsible for explaining the new equity compensation plan to those whose compensation is affected?

  5. Are we using the right equity vehicles (e.g. stock options, restricted share units etc.)? If we give more equity to non-executive employees, would we have to change the equity vehicles we are using?

  6. Do we want to use our equity grants to foster a pay-for-performance environment? What are the advantages and disadvantages of tying performance to awards granted? Would this be as simple as using Performance Shares?

  7. Who are the decision makers and idea generators in our company? How should this affect the level of employee we grant equity to?

 

More On…

  • Efficient Growth

    Learn more about CEB's work on the few companies that outperformed their peers across the past 20 years.

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