Executive Bonuses: Why Playing the Long Game is the Key to Company Success
Executive Bonuses: Why Playing the Long Game is the Key to Company Success Reuters

With the European Union's bankers' bonus cap coming into effect this year, its regulatory body is already looking at other ways to control cash bonuses.

As a result we will likely see companies put more emphasis on long-term incentive plans. To avoid the cash moniker, many firms will look into stock-based compensation, under the assumption this will tie their team to company profitability and sound management.

However, as the US has shown when shares are offered as part of a remuneration package, this does not always work.

The US Model

Here is what we have learnt in the US.

Let's start with pure share grants (known as stock grants in the US). The idea with this is that you give employees a grant of shares that vest over time with the idea that this will motivate the employee to increase the value of the company to boost the value of their stock.

Typically most US schemes will run to a schedule whereby 25% of the shares are the employees after one year of employment, and the remaining vest on a monthly basis until they 'own' all of the shares, usually at the end of five years.

While it is true employees will benefit more if the company's stock price rises, sometimes this rise in value is due solely to market conditions and has little to do with individual performance.

Worse still, the impact of a 5% drop in value will not have that significant of a hit on the employee - they still vest in their shares, regardless of performance, and receive a nice pay-out without ever contributing to overall company success.

Long Term Targets

Companies should add performance requirements to the vesting schedule.

In addition to just showing up with a pulse on the vesting date, shares should be made contingent upon other performance metrics such as profitability, growth, expansion into new markets or any other definable, measurable metrics the employee can impact.

Then, as they hit their performance goals they can accelerate their vesting, or they lose the shares.

Done properly, you can now tie short and long-term performance to the award.

The same technique can work with stock options - where the employee is granted the ability, but not the obligation, to purchase shares at a specific price.

The thought process on these grants is that since the employee only recognises value when the share price increases - this must align the employee with the shareholders.

However, the market might increase 10% while the company's shares only increase 5% - and the employee will still make money despite the company underperforming relative to the market.

In addition to the performance plans mentioned above, companies can go further and grant shares with an exercise price higher than the current trading price - telling the employee they have to grow the firm by a certain amount above and beyond market growth before they receive any value.

Pay for performance is a great tool for communicating what is expected. Leveraging shares can help tie the employee to the interests of the shareholders.

The Remuneration Committee still needs to go one step further, however, to ensure that all goals are being met. The solution to the Bonus controversy should not be a payment plan just as problematic as the issues it tries to solve.

Erik Charles, is the director of product marketing and principal incentive strategist at Xactly, which is a sales compensation and performance management software firm.