Executive compensation: understand what it is, the main advantages, examples and 5 tips on how to adopt it in your company

The variable compensation system for executives consists of paying employees at this hierarchical level according to their performance. Thus, this type of compensation has a direct impact on a company's results and on the maintenance of corporate governance practices.

Because it is a mechanism that links executive compensation to the organization's performance, it thus contributes to promoting a more effective strategic alignment between the criteria for executive pay and long-term value generation .

So that you can better understand this subject, we recommend that you continue reading this article.

In the following lines, we will explain what variable compensation for executives is and how it works , the benefits that this compensation system can bring and some examples of publicly traded companies that adopt this mechanism to remunerate their executives.

In addition, you will also check out 5 essential tips on how to apply variable remuneration to your company's executives:

1. Consider strategy and value generation
2. Use KPIs
3. Create a Compensation Committee
4. Set clear rules
5. Research how the market pays its executives

What is executive compensation?

Executive compensation consists of a system in which the payment made to professionals who occupy senior positions in a company varies according to the individual performance of each executive and the organization in the short and long term.

Variable remuneration for executives works as an important management tool, being extremely relevant to align the efforts of those who occupy these positions with maximizing the value generated by the organization.

Short-term variable remuneration

The main basis for short-term executive compensation lies in compensation for achieving previously established goals , which are paid in the form of bonuses.

Long-term variable remuneration

In the case where executive remuneration is done in the long term, they receive payments through company shares (stock options).

In this case, executives can receive in installments the gains from results from periods that generally range from 1 to 5 years.

According to a survey conducted by PwC, variable compensation in the short term is the most common method for rewarding executives of publicly traded companies.

The most commonly used formats for making these variable payments are profit sharing and performance bonuses.

The advantages of variable executive compensation

Implementing a variable executive compensation system is a way of promoting sharing not only of the company's results, but also of the risks of its strategic decisions.

Additionally, other advantages worth mentioning are:

• greater alignment between the interests of executives and those of shareholders;
• maintenance of organizational culture;
• strengthening corporate governance practices;
• recognition of efforts;
• greater engagement and talent retention.

Examples of companies with variable compensation for executives

Many publicly traded companies use variable compensation for their executives. In USA, on average, the compensation components (fixed salary, short-term bonuses and long-term incentives) are well balanced.

Check out below some examples of how the proportion of variable remuneration is determined in the companies included in the study carried out by the consulting firm SG Comp Partners:

5 tips on how to apply variable compensation for executives

To apply variable executive compensation, there are some basic recommendations to be followed.

See below for tips to put into practice:

1. Consider strategy and value generation

Think about the business approach used to reward the elements that are most important to the firm in order to maximize value creation.

2. Use KPIs

Make use of a solid system of performance indicators , which must be aligned with the company's strategy.

This way, both the company's management and executives will have reliable information about their performance and consequent remuneration.

3. Create a Compensation Committee

This committee will be used to analyze and define the best strategy and the most appropriate method to remunerate executives, generating consensus and greater engagement.

4. Set clear rules

Be clear when establishing and validating variable remuneration criteria, amounts, receipt dates, accumulation of bonuses and commissions, etc.

5. Research how the market pays its executives

Consider the current market reality and research the factors used by other companies to determine their variable compensation. This way, you will know if your performance incentive program is attractive to top talent.