5 key issues for nonprofit boards of directors looking to align executive compensation programs with evolving business strategies and best position their organizations for deal success
With market pressures squeezing healthcare systems more than ever — due mostly to the Patient Protection and Affordable Care Act and the industry consolidation it's driving — 2014 health care merger and acquisition spending skyrocketed 152 percent in Q2.
Nonprofit boards of directors looking to align executive compensation programs with evolving business strategies and best position their organizations for deal success in healthcares rapidly transforming landscape should consider the following five questions, along with what we consider to be best-practice approaches to each.
Q: Does your executive compensation philosophy reflect current reality and support key objectives necessary for deal and ongoing business success?
A: Ultimately the executive compensation philosophy supports the attraction, retention and motivation of executives with the competencies necessary for success. So healthcare systems need programs that align with the goals they are working to achieve today, which are likely very different from those of last year or even six months ago.
Organizations contemplating, or already in the midst of, an M&A transaction must pay particular attention to their executive compensation programs. For example, a provider may not be well served by a program that continues to incent volume-based care in what is fast becoming a value-based market. This shift may require a change of focus in the program to incentivizing better outcomes at lower costs, with leadership goals changing from growing inpatient revenue to emphasizing outpatient procedures, quality, safety and patient satisfaction.
During a transaction and at least annually, the executive team, compensation committee and board should review the philosophy in detail to ensure that the organization's dynamic strategic objectives are being served. If these objectives are not being served, revisions to the philosophy should be made.
Q: Do current severance and employment agreements afford appropriate protection for executives during a transaction?
A: It's not in an acquiring organization's best interests when executives who are managing details of a transaction are preoccupied with their paychecks. At the same time, it's important that there are no provisions in a severance agreement or employment contract that would be unacceptable to executives of the target organization. Ideally, severance protection takes away some of this worry and allows key executives to focus on maximizing deal success —whether or not their jobs will be part of the organization once the transformation is complete.
According to Mercer's "2013 Health Care CEO Severance Survey," 90 percent of respondents provide severance on involuntary termination without cause, and 65 percent specifically address a change-in-control.
Organizations and boards should negotiate severance at the front end of a transaction, keeping in mind that an agreement is a business deal, not an emotional event. Agreements should be based on industry benchmarks so that surprises or outliers that could compromise an organization's budget or morale can be avoided. In the end, severance can be a strong attraction and retention tool.
Q: Are termination provisions and definitions appropriately crafted to retain key executive talent during a transaction?
A: For key leadership talent integral to the new organization's financial success, it's critical that employment contracts and severance provisions be carefully worded. The goal is for those who continue in a role post-deal to not be financially motivated to leave an organization prematurely of their own volition.
It's well known that the majority of deals never reach their full potential. But perhaps less known is how often the loss of top talent causes a deal to languish. According to a Mercer survey of 372 senior business leaders worldwide, loss of key talent is one of the top reasons cited for deals that did not achieve projected value.1
According to Mercer's "Survey of M&A Retention and Transaction Programs," among 42 organizations globally, retention incentives and transaction bonuses are the two main tools for retaining talent in transactions. Organizations should review their acquisition strategy to determine whether use of these tools makes sense and then assess who should benefit from them, along with the nature, timing and structure of awards and associated costs.
Q: Do executives currently possess the competencies and capabilities needed to drive short-and long-term outcomes, and how can gaps best be addressed?
A: Talent assessment should not just focus on potential transactions. Rather, organizations need to make it part of a best practice around overall succession planning — looking at bench strength within the company, where there are gaps and how those gaps can be filled (through either build or buy strategies, including strategic affiliations or transactions with other organizations).
Within the transaction process, talent assessment needs to be contemplated early during due diligence to avoid surprises when the time for implementation arrives. Special attention should be paid to some of the industry's faster-growing C-suite positions, such as chief population health officer and chief transformational officer, roles which are emerging in response to specific skills needed in today's new healthcare landscape. At the same time, physicians have begun assuming leadership roles that historically have been held by non-physicians. Careful consideration must be given to the best approach for developing this new breed of physician-executive talent.
Q: Do current variable pay strategies provide appropriate alignment of performance and rewards, and how can these programs be refined in a transaction to better drive desired outcomes?
A: M&A transactions provide a valuable opportunity to revisit all compensation programs, including variable pay programs. In this age of nominal increases in salary budgets and tight industry margins, variable pay schemes — both short-term and long-term incentives — have become more prevalent and will continue to comprise a growing portion of an executive's overall pay package.
Organizations need to have metrics in place with variable pay programs that are appropriately tied to desired outcomes. The goals must be a stretch, but achievable. Executives will modify their behavior to achieve the outcomes set forth in incentive programs. Ensuring that these outcomes aren't incenting unintended inappropriate behavior is of the utmost importance. Careful consideration should be given to this.
For example, perhaps an organization is incentivizing inpatient volume within its plan when the main goal is moving care out of the hospital to an outpatient or clinic setting. Or maybe the organization is actually penalizing executives for moving forward with an affiliation or transaction that is appropriate for long-term success but forces it to take a hit on financials in the year of the acquisition, thereby causing the bonus program to not pay out and potentially incentivizing behavior that is counter to the long-term strategy.
Finally, organizations should continue to explore new performance measures with their variable pay programs — those that are now particularly meaningful under PPACA, such as community wellness or population health, and those that historically may not have been a part of incentive programs but should now be in order to reinforce an organization's evolving business strategy.
Conclusion
As deal activity picks up even more, healthcare providers looking toward M&A as a key growth strategy will do well to keep an eye on executive compensation, making sure programs remain aligned with healthcare reform's ongoing transformation of the industry.
Patrick O’Cull is a principal and office business leader for Mercer’s Detroit office. He has twelve years of executive and broad-based compensation experience.
Tayloe Negus is a principal in the Richmond office of Mercer. In this role, he leads the local Virginia office and manages a number of the firm’s client relationships in the Virginia market. He has more than 22 years of professional experience, almost entirely based in the Virginia market.
1 The Mercer 2013 Global M&A Ready™ Executive Development Program registration survey was conducted among 372 senior business leaders who registered to attend the program in locations worldwide.