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DESIGNING INCENTIVES THAT DRIVE GROWTH

Background

A small-cap manufacturing company needed to update its compensation for the company’s top seven executives, including the CEO who expected to retire within three years.

As part of its regular, periodic compensation assessment, the company’s compensation committee sought to rework the existing executive compensation package, including incentives. Specifically, the committee asked Frost HR Consulting to identify shortcomings in the executive compensation program that the committee then wanted to address so the company could appropriately award and retain current executives and, as necessary, attract talented future executives.

With the impending retirement of its CEO, the committee also felt some urgency to resolve compensation issues so the successor CEO would be compensated appropriately. Because the company’s hallmark is innovation in a niche market, it also looked to executive incentives to drive new research and development that would ultimately increase corporate revenue.

The company’s goals:

  • Resolve existing executive compensation issues
  • Create a competitive, performance-driven compensation plan in preparation for a new CEO
  • Drive new research and development as a way to increase corporate revenue and growth, thereby increasing shareholder value.

Approach

Frost HR Consulting was contracted to complete a compensation assessment of the company’s top seven executives, then with the compensation committee’s input design incentives that would drive performance and company growth.

Frost HR Consulting’s primary goals:

  • Determine the market value for each executive’s position
  • Create a compensation plan that would deliver above-market incentives when executives performed at above-market levels

The project followed a step-by-step process:

  • Consultants gained familiarity with the company, learning what makes it unique in the marketplace through interviews with executives and board members, as well as a review of its website, public documents and articles about the company plan documents, and other research documents. In addition, the interviews of executives and board members included inquiries into their perceptions about the current compensation plan, focusing on what worked well and what needed fixing.
  • Consultants determined which companies in the marketplace could be reasonably considered peer companies to the client. Peers were chosen based on a variety of factors, including their size, industry, geography, scope of operations, market niche, revenue, market cap, enterprise value and assets. In this project, consultants worked to identify a unique peer group that would closely match the unique and specialized nature of the client company.
  • Consultants benchmarked each executive position included in the project against like positions in peer companies. They compared base salaries, total cash and total direct compensation at the 25th, 50th and 75th percentile and all other components of compensation as reported by peer companies’ proxy statements. For each position, consultants determined whether the client executive was above or below the market median in each compensation element.
  • Consultants also reviewed performance measures in the client’s annual and, if applicable, long-term incentive plan, comparing those to the peer companies.
  • Consultants made recommendations to the board of directors’ compensation committee about adjusting base salaries and specifically advised the company to substantially increase several of the executives’ incentive targets and long-term awards.
  • Consultants, with compensation committee insights from the interviews, designed target awards for both long-term incentives and annual incentives as well as performance measures that supported the company’s desire to promote research and development and grow the company.
  • Consultants worked with the company to create a solution for the current CEO to receive long-term incentives even while approaching retirement.
  • Consultants simulated ISS pay-for-performance assessments to determine if CEO proxy-disclosed, realizable and realized compensation aligned with corporate performance compared to peer companies.

Results

Frost HR Consulting helped the client increase revenue by designing incentives that promoted research and development, a key driver of growth for the company. In the three years after Frost HR Consulting revamped the company’s executive compensation plan, revenues grew 21.7 percent, or 7.2 percent annually, without acquisitions.

Additionally, the plan designed by Frost HR Consulting allowed the company to continue long-term incentives for the outgoing CEO (without worrying about losing unvested shares), enabling him to make a smooth transition into retirement.

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