Human capital14 February 2018
Given the aspirational goals of most nuclear power programmes, executive compensation plans should be designed with a long-term view, Paul Lalovich explains.
DESIGNING COMPENSATION PROGRAMMES THAT drive the highest safety standards, and retain and motivate key executive talent, while maximising shareholder value, is a challenge for companies. It is particularly important in new nuclear build, where the stakes – requiring safety and cost impacts to be managed – are higher.
Energy is an unpredictable market, so structuring pay packages can be a daunting task. The goal is to avoid critical executive departures, manage the ire of third-party shareholder advisors and the media, and respond to increasing market pressures.
To do that, companies must ensure compensation programmes are reasonable and tailored to their organisations and operating environments. This can be accomplished by examining the competitiveness of the arrangements, and considering whether executives will be adequately motivated in the short and long term.
Properly structured compensation programmes are effective in retaining and motivating executives over different periods of time. Annual incentive plans measure short-term performance (generally, over a one-year period) and long-term incentive plans measure performance over several years.
Understanding executive pay from the global market perspective, while also maintaining an insight into how local competitors compensate their executives are both critical to the design of all executive compensation plans. Companies tend to link compensation to short and long term corporate objectives and traditionally, variable pay has been linked to factors like profitability and revenue growth. But the nuclear sector has additional pressures: companies also have to account for the effect of product liability costs, environmental cleanup costs, and environment and employee safety on their reputations, profitability, and ultimate corporate survival. There must therefore be an environmental health and safety (EHS) component in their executive compensation structure.
Developing the compensation strategy
The compensation strategy must support the business strategy. There are many different approaches, but they all start by answering following five questions:
How Much to Pay? Or what is the appropriate pay positioning in the market? Market position is specific to each organisation based on the strategy, target operating model, competitive landscape, availability of talent, etc. Deciding on “at risk” earnings within packages will be essential. If a package has too little variability and is too short term it will allow for freeloaders; but if it is highly variable and too long term it will come across as difficult to attain. A typical mix that works well is 40% of fixed pay, with 30% long-term and 30% short-term incentives.
Who to Pay? To segment the top layer of your organisation and affect their behaviour by rewarding them, you first need to define critical jobs. These are ones that contribute to the long-term strategic success of the organisation and those that employ scarce skill sets with significant lead time for recruitment or training. Market practice is to provide short-term incentives to executives, senior management and employees in critical jobs. Long term incentives are exclusive to executives in critical jobs.
How to Pay? Given that most new-build programmes are in emerging economies and designed for a significant proportion of expatriate employees, plans will be largely cash-based. Share plans or equity-based plans are not likely to be an option, if the company is not publicly traded.
What to Pay For? As the nuclear programme matures it is important that executive compensation strategy matures with it. During the construction and build phase, clearly the accent will be on milestones and internal rate of return (IRR). As the organisation approaches operations, the shift will be towards supply of consistent baseload electricity, and earnings growth. Environmental protection, safety, proliferation resistance and physical protection are embedded throughout the lifespan of the programme. Long-term incentives should be milestone vesting with cash payments upon completion of the milestone in accordance with performance measures. Target levels of award are set to ensure that the plan is self-funded from realised savings, making a positive impact on the bottom line while meeting EHS targets.
When to Pay? To drive corporate behaviour, each measure will be evaluated over a period required for a milestone completion to accurately capture long-term performance. For best outcomes, rolling parallel annual awards should be issued on an annual basis, whereby each scheme runs for three years, and a new scheme starts each year with an annual award. To ensure incentives are effective in retaining staff as well as providing full accountability, a portion of the incentive award can be deferred over time. This may include performance-based vesting criteria which considers how business results in an award year develop over several years (for example, the performance of 2017 will be re-evaluated in 2020).
Driving a top performing business requires a competitive construct for executive management compensation made up of current and also long-term forward-looking rewards.
More importantly, the packages offered to the executive management population have to be attractive to a top-performing candidate pool. They must encourage retention of employees in mission-critical jobs.
Holistic long-term incentives generally yield better results and more return on investment than incentives focused on retention or engagement alone.