One of Peter Drucker’s notable expression was: “Culture eats strategy for breakfast.” In fact, culture shapes behaviors, where plans and structures only attempt to influence them. Long-term incentives, compensation programs tied to a company’s future, market value and long-term performance, either reinforce the culture or are undone by the culture. These compensation programs can squander ownership interests, or they can drive them. This paper will briefly show how different types of long-term incentives align with the culture that companies create for themselves.
Corporate culture is defined by the norms and types of behaviors as experienced by the people who work for or with the company. If you want to know where it comes from, ask people “What gets rewarded and what gets punished around here, and how?” You’ll learn a lot about a firm’s culture.
Long-term incentives are programs like stock-options, restricted stock units, multi-year bonus programs, phantom share programs and capital accumulation or wealth creating programs like Supplemental Executive Retirement Plans (SERPS), deferred compensation and annuity or life insurance programs. Their value to the individual is created over time and based on retention, corporate performance, or both.
Let’s look at which long-term incentive program fits best with different cultures. For understanding cultures, I will use a model developed by Robert E. Quinn and Kim S. Cameron of the University of Michigan School of Business, called OCAI (Organizational Culture Assessment Instrument). Here is a description of their four types of corporate cultures and the kind of long-term incentive plans that may align best with the culture.
“We’re like a family.” This is a good description of this kind of culture. These firms have strong loyalty, traditions, and caring for each other. They encourage open communication and collaborative decision making. They are a highly interdependent organizations and leaders act like mentors and guides for the values on which the firm is based. Good examples are Zappos, Ben & Jerry’s, and Tom’s of Maine. Capital accumulation programs like 401(k) contributions through profit sharing, annual contributions to SERPS, deferred compensation, company funded life insurance, all encourage longevity, togetherness, and long-term continuity of the company in order to benefit from this approach to compensation. They may utilize multi-year or long-term cash incentive plans to reinforce a performance orientation, but they tend to be more interested in the general prosperity of the “family” than achievement of specific goals and objectives. Relative to other cultures, participation may go deeper into the organization. They are generous and create a true sharing of the firm’s prosperity.
“Be innovative and disruptive.” This is the mantra for organizations with this type of culture. The term “Ad hoc” refers to creating something new, experimental, try new ideas; it is Latin for “to or for this.” These firms operate with little structure, are very entrepreneurial and encourage employees to take risks and act on their ideas. They learn from their experiences, make rapid adjustments, and continue their pursuit for growth. Phantom share plans provide a mechanism to share the value created by the organization over time. Like a stock-based program, these are usually for private companies and are intended to simulate equity but provide the company with greater flexibility. People can receive periodic awards, and the value is based on the growth and profitability, the long-term value of the company. They may also utilize project-based long-term incentives, such as milestone programs and product development incentives, where the timeframe and results for the project stretches over multiple years. Hence, individuals become rich when their ideas, and those of their colleagues, translate into firms that disrupt the market and create incredible value. Facebook and SpaceX did this, as well as many emerging technology companies.
“We will achieve greatness.” Companies with this culture are driven to compete, overcome obstacles, and achieve incredible results. They focus on what they want to accomplish, then are driven until they are successful. Once reached, they redefine new goals and launch into the next direction. They are never satisfied, and continually seek to compete with others and win. These are high-pressure environments and are simultaneously exciting and rewarding for all that is learned and accomplished. Companies that characterize this culture are Amazon, Google, Apple (under Steve Jobs), and many high-growth oriented companies. Stock options are then their customary long-term incentive tool. The value of the option is based on the growth over the price when it was initially awarded. If the value of the option grows substantially, there are incredible rewards. If they fail, the options become worthless. Stock options have limited cost associated with them when awarded and can be awarded broadly to the employee population. The success of the firm in the market will determine the value and ultimate rewards to the participants. Also, the number of options one receives is usually tied to their individual performance (within certain guidelines), which also reinforces internal market competitive conditions.
“Plan-Do-Check-Act.” Companies with this culture focus on where they provide the greatest value, plan and manage their actions accordingly and continually improve the process. They are professional organizations that have effective controls and reliability systems to assure their goals and standards are achieved. There is strong clarity, communication, predictability, and sense of stability. They work well in regulated or high reliability-demanding environments and may in fact be the regulator for others. They prioritize goals, objectives, policies and procedures, and have strong standards for performance. Companies like insurance, aerospace manufacturing, elements of pharmaceutical companies, banking organizations and cultural institutions are typical promoters of successful hierarchy culture. In this context, restricted stock awards or units and long-term cash bonus plans provide both income and growth potential. The full-valued equity tools provide awards whose value is retained and grows over time, and the vesting associated with them are usually based on achievement of strategic goals and sustained market value. Long-term cash plans usually make their payouts and the income can be deferred, invested, and grow over time. These long-term incentive tools tend to be stable and provide opportunities for wealth creation over the long-term and reinforce retention. Because of their inherent cost, they are usually only available to the leadership of the organization, those who are charged with the long-term responsibility for the growth and success of the enterprise.
Corporate culture is a powerful force. There are many things that shape and are shaped by it. Long-term incentive, especially for executives and senior leaders, is often the primary driver of income and wealth. Therefore, their alignment is often critical to both a successful culture and future income for the participants in these programs. Few organizations have a monolithic culture and these programs are seldom designed in a simplistic manner. Finding the power in the nuance is the challenge of the program designer and manager. As was quoted in Indiana Jones and the Last Crusade, “Choose wisely.” We at the Wilson Group are here to help you make the right decisions.
|Type of Culture
|Type of LTI Plan
|Capital Accumulation Programs
|These plans build wealth over time based on the prosperity and contributions of the company
|They reinforce loyalty, retention, and actions for the common good; people share in the prosperity of the firm
|Phantom Share Plans
|Highly flexible equity-simulator type plans, highly performance focused, may be project or multiple measure based
|They create opportunities to share in value creating outcomes that may differ by level, focus and eligibility
|Stock Options Plans
|These plans can create significant wealth based on the growth from the initial grant; they also have more risk than other plans; the number of options one receives is based on role and performance; vesting is usually based on time; the growth in share price drives the value
|They are generally well understood and common in high-growth companies; they enable people to share in the growth in the market value of the enterprise; people receive option awards over many cycles, hence building wealth over time
|Restricted Stock Plans
|These plans award individuals full value shares in the company, with vesting based on performance; may include long-term cash incentives that reward goal achievement- based performance; because of their cost, they are usually limited to senior leaders
|These plans offer less risk because the firm is focused on reliability, predictability, and sustainability; individuals share in the growth of the firm through restricted shares or achievement of long-term (3 – 5 year) goals