Compensation Goals in the Stakeholder Era
The choice between serving all stakeholders and shareholders alone is not binary. This is a point that has, in my opinion, gotten lost in recent editorials that debate whether companies should shift their accountability from just shareholders to all stakeholders. The challenge for company leaders has long since ceased being whether to operate in the interests of employees, customers, suppliers, and the communities. It is now, and has been for some time, how and how much they will operate in the interests of each.
For boards, today’s renewed focus on stakeholders codifies a reality that has slowly but surely inched into place in the minds of most corporate leaders. In the long term, the only way to win for shareholders is to serve the interests of all stakeholders. The key question now is: Which stakeholders’ interests should the company serve to create the most value?
Figuring that out will require a better understanding of each stakeholder group. What does the company need from each? And what does each group need and want in return? This is not aimed at re-dividing the pie of corporate wealth creation to give stakeholders bigger slices. It is about finding an approach to grow a bigger pie.
The new stakeholder emphasis implies that the board must grasp, document, and measure the implicit and explicit “deal” cut between the company and each stakeholder group. From that understanding, directors on the compensation committee can set goals for strategic achievement, corporate performance, and executive rewards. My firm suggests three steps:
- Identify key stakeholders and their interests. What do stakeholders need and expect if they are to give the company what it needs to create long-term value? What is each stakeholder’s value proposition? Does the company’s mission statement need to change to address this new thinking?
- Resolve tradeoffs. What are the company’s top priorities, and which stakeholders position the company to win? What will and won’t the company do for each group?
- Create accountability for priorities. How can the compensation committee focus and align executives through goal setting and pay?
One Company Charts the Stakeholder Seas
Imagine you’re on the board of a company that has embraced the stakeholder approach. For the sake of example, let’s illustrate with a company that has already become a premium brand name for its stakeholder efforts: Trader Joe’s.
The privately held food retailer has used the stakeholder approach like few other firms. If you visit a Trader Joe’s store, you see for yourself why it has earned a top ranking as a best place both to work and shop at. It’s apparent that the company meets the needs of both employees and customers.
As for employees, Trader Joes serves their interests—and thereby fuels their energy and loyalty—through wages, training, and career opportunities. Few companies can boast the high levels of customer satisfaction that indicate a high-quality, engaged workforce. The American Customer Satisfaction Index rates Trader Joe’s first among all retailers. Store associates engage customers and win their loyalty because shoppers instantly recognize and relish the employees’ work to make shopping easy, rewarding, and even surprising.
Because the company is privately held, and is notorious for keeping its cards close to its vest, we can’t know what the Trader Joe’s board has approved for executive incentive plans. But we can infer that goals for delivering premium value to both employees and customers are a part of their equation. Meeting such goals allows the retailer to continue to differentiate itself as if in a league of its own. It offers premium, store-branded products that generate a cult-like following. It fields helpful, informed store employees who can tell customers about those products. And it offers low prices without sales promotions in stores that, by constantly updating based on employee input, delight customers.
Other companies can mimic the stakeholder approach of Trader Joe’s—working with shareholders, customers, employees (and probably suppliers) to win together. The point is not to copy its business model, but to copy its example of creating value through—rather than at the cost of—fulfilling stakeholder needs.
What can your company take away from the success of this stakeholder-focused model? If your company were to shift its approach to take the stakeholder view, how would you design your pay plan? To start, your executives would go out to shareholders and ask, What are your needs and expectations? As a director, you could then build goals from the answers.
Goals for corporate financial performance have not changed that much over the years, so you would probably settle for conventional targets. Likely measures of success include overall sales growth exceeding peers, profitability, return on investment above the company’s cost of capital, and total shareholder return that outpaces peers.
Executives would do the same investigation with customers. What are the customers’ expectations? Directors might choose targets related to satisfying customer experience while interacting, buying, and resolving customer-service issues; appealing product selection consistent with brand strategy; fast and easy delivery and returns; and competitive pricing.
Executives would take the same approach with employees. The resulting targets might include adequate wages and benefits to meet personal and family obligations; adequate work hours and predictable or family-friendly work schedules; long-term career potential; and a satisfying and engaging work environment.
That would leave the job of making tradeoffs and accommodating realities. Do the goals take into account the company’s training programs? Its employee culture? Do they recognize the limitations of logistics systems? Of inventory management and sourcing?
After this reality check, the compensation committee could set goals for the annual bonus plan that support immediate and intermediate-term progress. Pay would depend on hitting significant, game-changing strategic milestones, often related to fulfilling stakeholder needs. This isn’t to say that all incentive pay would be based on meeting goals set for every stakeholder. Bonus plans have room for only a precious few targets. Directors have to be selective. But the board has flexibility to pick and choose targets for the maximum impact each year.
Complementing the annual bonus plan, the long-term incentive plans might include both conventional financial goals as well as nonfinancial ones demonstrating that management is meeting the stakeholder expectations most critical to value creation. Examples of a few goals in such a long-term plan include:
- total shareholder return exceeding peers,
- customer retention levels continuously improving,
- growth in average customer spending, and
- average employee tenure versus best-in-class for the industry.
Even though not all stakeholder interests are equal, their order of priority will of course change every year. With each new strategic initiative, management and boards need to reassess: Through which stakeholders above all will the company win?
This can pose a complicated set of tradeoffs. But in solving the more complex tradeoff equation each year, executives and directors will assure the company delivers for shareholders—higher profits and returns—as well for the stakeholders whose performance the shareholders depend on.
Read this article by Seymour Burchman as it originally appears at NACD BoardTalk.