Let’s Integrate Compensation with Risk

Corporations face never-ending threats to their established businesses.

At nearly two-thirds of all corporations, the full board has the primary responsibility for risk oversight (with delegation to its committees), according to a 2012 Spencer Stuart survey. These board risk discussions cover financial, IT, reputational and regulatory risks, among others.

But a subject receiving less attention in boardrooms is the organization’s ability to adapt to disruptive threats in the competitive landscape — and the impact of corporate compensation packages on the organization’s ability to adapt.

Most corporations easily grasp the standard dynamics of rivalry among existing industry competitors for market share and profitability. And directors are aware that competition can come from suppliers as well as from customers. In fact, if the company’s position is weak, suppliers and customers may work into your space and cut you out, too.

Business and operational management (including, sales, marketing, manufacturing and purchasing) seek to address these well-recognized threats. And most often, executives in these functions have performance objectives — and corresponding incentive pay — linked to straightforward factors, like improvements in revenue, profitability, reliability, and safety of existing product lines.

But companies today increasingly face bigger perils that change the game. The risks of substitute products or services or of new entrants into the industry represent potentially disruptive and non-linear threats. Technology and new-business-development managers generally concentrate on these concerns. And their performance objectives, and associated incentive pay, focus on introduction of next-generation and step-out products. These step-outs frequently require the establishment of new business models and markets as well as changes in manufacturing and supply-chain sourcing, as examples.  

But despite the growing relevance of the non-linear risks, boards and senior teams too often focus their primary attention on keeping the existing business running. In fact, step-outs are often viewed as a distraction.

As a result, too often, corporations are slow on the draw. In fact, the case for substantial change has to be compelling for companies to drive a potentially disruptive product into the market or respond to new forces. Examples abound, including letting niche and inferior products establish a foothold in the low end of the market and grow (think: Clayton Christensen, The Innovator’s Dilemma.) Now cloud computing, social media, big data, new materials, and diagnostic tools, among others, are part of the fast-paced change.  

Delays from organizational misalignment can be damaging. And the disparity in objectives and incentives come to a head in the C-suite, ultimately residing with the CEO. 

Boards can help solve this conundrum by establishing a dialogue that includes not only current competitive dynamics but also potential disruptive threats. Within that broader conversation, boards should ask the CEO to set cross-functional performance objectives, that address routine as well as non-linear threats – and ensure pay is aligned with these objectives.  While this may sound difficult, the way many large industrial companies, like Dupont and Chevron, have implemented effective cross-functional safety programs can serve as a model for what boards need to do.    

Part of the board’s oversight role is to understand how the organization’s compensation packages align with the broad competitive landscape. In doing so, the board needs to ensure the organization takes all appropriate threats seriously, and balances those objectives, while not undermining the existing businesses.