James Otto of the Hay Group discusses four trends affecting for-profit hospital executive compensation, including incentive plans, the decreased use of stock options and scaled back severance provisions.
1. Annual and long-term incentives will become increasingly important. Annual and long-term incentives are already a significant percentage of the "compensation pie," according to Mr. Otto, and he thinks that percentage will only increase in the future. "I would envision that additional significant dollars to a compensation package will be delivered in the form of incentives," he says. He says the structure of incentive plans can vary widely between organizations and should be reconfigured annually based on how the hospital's goals and financial history have changed.
When compensation committees draw up incentive plans, Mr. Otto says they should consider how the incentive plan will be affected if the hospital is financially unstable for reasons beyond the reach of the CEO. "A lot of committees struggled with that in 2008 and 2009," he says. "If the executive group was performing and doing what was being asked by the board, and the economy just went the way it went, should that result in no pay-out?" He says the answers to that question run the gamut, but given the volatility of the economy, organizations might consider measuring CEO performance and rewarding incentives over shorter periods of time, when financial performance is more predictable.
2. Use of stock options as compensation will decline further. During the last 5-10 years, Mr. Otto says stock options fell out of favor as accounting rules changed to require stock options to be expensed. The accounting standard was adopted by the U.S. Financial Accounting Standards Board in "statement 123" and is thought to improve transparency and accountability in organizations. The move also "levels the playing field in terms of what the accounting cost was to the company by using stock options versus something else," Mr. Otto says.
Stock options have also become less popular as share price appreciation does not necessarily reflect the value of an executive's performance. "There are activities we want to measure that we think drive value within this organization that we also believe will ultimately be reflected in the share price, but there's not necessarily an A+B=C equation," he says. Positive executive performance may drive share price appreciation in the long run, but rewarding executives with stock options may not be the best and most direct way to incentivize good performance.
3. Severance provisions will be scaled back or eliminated. Employment agreements traditionally include severance provisions, meaning if the executive is involuntarily terminated without cause, he or she is paid severance meant to smooth the transition between jobs. Increasingly, Mr. Otto says, organizations are decreasing or eliminating severance pay or basing severance on the executive's incentive plan, meaning severance is paid based on the executive's performance over the last year.
"I think the amount of severance paid will continue to decrease," Mr. Otto says. "Over the last nine years, there have been infamous severance payouts for CEOs who did not perform [well], and the media looked at those numbers and said, 'This is pay for failure. Why are the shareholders giving up millions of dollars in value for somebody who didn't work out?'" He said recently, committees have considered whether severance is necessary when employees often subscribe to other plans that provide support in the event of involuntary termination.
He says going forward, severance payments to executives may be governed by a company-wide policy that places a cap on payouts. "If a general severance policy says, you get X number of weeks salary [following termination], that's usually capped out at a level that is much lower than the multiple of base salary provided to executives," he says.
4. Perquisites will grow increasingly scarce. According to Mr. Otto, organizations are eliminating perquisites more and more as the business rationale for executive "perks" is more highly scrutinized. "Committees are looking at why we have perquisites, and if there's no good business rationale for having a company car or an allowance, we'll continue to see those decrease," he says.
Mr. Otto predicts organizations will still retain benefits — such as supplemental life insurance and supplemental disability — that allow the executives and their families to derive benefit for their well-being.
Learn more about Hay Group.
1. Annual and long-term incentives will become increasingly important. Annual and long-term incentives are already a significant percentage of the "compensation pie," according to Mr. Otto, and he thinks that percentage will only increase in the future. "I would envision that additional significant dollars to a compensation package will be delivered in the form of incentives," he says. He says the structure of incentive plans can vary widely between organizations and should be reconfigured annually based on how the hospital's goals and financial history have changed.
When compensation committees draw up incentive plans, Mr. Otto says they should consider how the incentive plan will be affected if the hospital is financially unstable for reasons beyond the reach of the CEO. "A lot of committees struggled with that in 2008 and 2009," he says. "If the executive group was performing and doing what was being asked by the board, and the economy just went the way it went, should that result in no pay-out?" He says the answers to that question run the gamut, but given the volatility of the economy, organizations might consider measuring CEO performance and rewarding incentives over shorter periods of time, when financial performance is more predictable.
2. Use of stock options as compensation will decline further. During the last 5-10 years, Mr. Otto says stock options fell out of favor as accounting rules changed to require stock options to be expensed. The accounting standard was adopted by the U.S. Financial Accounting Standards Board in "statement 123" and is thought to improve transparency and accountability in organizations. The move also "levels the playing field in terms of what the accounting cost was to the company by using stock options versus something else," Mr. Otto says.
Stock options have also become less popular as share price appreciation does not necessarily reflect the value of an executive's performance. "There are activities we want to measure that we think drive value within this organization that we also believe will ultimately be reflected in the share price, but there's not necessarily an A+B=C equation," he says. Positive executive performance may drive share price appreciation in the long run, but rewarding executives with stock options may not be the best and most direct way to incentivize good performance.
3. Severance provisions will be scaled back or eliminated. Employment agreements traditionally include severance provisions, meaning if the executive is involuntarily terminated without cause, he or she is paid severance meant to smooth the transition between jobs. Increasingly, Mr. Otto says, organizations are decreasing or eliminating severance pay or basing severance on the executive's incentive plan, meaning severance is paid based on the executive's performance over the last year.
"I think the amount of severance paid will continue to decrease," Mr. Otto says. "Over the last nine years, there have been infamous severance payouts for CEOs who did not perform [well], and the media looked at those numbers and said, 'This is pay for failure. Why are the shareholders giving up millions of dollars in value for somebody who didn't work out?'" He said recently, committees have considered whether severance is necessary when employees often subscribe to other plans that provide support in the event of involuntary termination.
He says going forward, severance payments to executives may be governed by a company-wide policy that places a cap on payouts. "If a general severance policy says, you get X number of weeks salary [following termination], that's usually capped out at a level that is much lower than the multiple of base salary provided to executives," he says.
4. Perquisites will grow increasingly scarce. According to Mr. Otto, organizations are eliminating perquisites more and more as the business rationale for executive "perks" is more highly scrutinized. "Committees are looking at why we have perquisites, and if there's no good business rationale for having a company car or an allowance, we'll continue to see those decrease," he says.
Mr. Otto predicts organizations will still retain benefits — such as supplemental life insurance and supplemental disability — that allow the executives and their families to derive benefit for their well-being.
Learn more about Hay Group.