A well-designed compensation system is an essential pillar of corporate governance. Not only can it attract and retain top talent, but it can also create structures that effectively incentivize performance and alignment with strategic objectives. But its impact goes even further: An effective compensation system also strengthens trust and transparency in management, contributing to the company’s sustainability and long-term value creation.
In times when corporate trust is built or lost around these principles, the way companies define and manage executive compensation reflects their corporate culture and values. It’s a tangible expression of the organization’s strategic priorities.
Faced with increasing pressure from investors, regulators and the public, managing the compensation of board members and senior management becomes a crucial issue. The question every company should ask itself is: How can we ensure that leaders’ incentives are aligned with the company’s purpose, sustainability and long-term value?
While there’s no single formula for designing effective compensation, applying best practices allows us to transform it into a real competitive advantage, ensuring that incentives are aligned with the means by which objectives are achieved.
Seven Tips To Help Make This A Reality
1. Define clear metrics, and tie executive compensation to performance.
The first step is to establish clear, concrete and measurable indicators to determine the fixed and variable compensation of the executive officers, ensuring a balance between short- and long-term incentives. Competitive salaries should be promoted to ensure good performance, continuity and stability, along with variable incentives that encourage them to meet long-term strategic objectives. A proper balance between these two components is key to aligning senior management’s interests with strategic goals.
2. Ensure the independence of the Compensation Committee.
The board of directors should appoint a committee responsible for overseeing and defining the executive compensation policy. This committee should be composed of independent board members who, in order to avoid conflicts of interest, should not be part of management or have relevant family ties.
In many jurisdictions, committee independence is a regulatory requirement for publicly traded companies, and in others, it is considered a best practice to guarantee independence and investor confidence.
3. Manage compensation risks.
A well-designed compensation plan seeks an appropriate balance between reward and accountability, incorporating controls that prevent incentivizing reckless behavior or conduct contrary to the organization’s values. It’s important to align incentives with compliance programs, ensuring that bonuses and benefits are awarded only when objectives are met fully and in accordance with internal policies. This promotes responsible and sustainable practices, reducing legal, reputational and financial risks.
4. Incorporate clawback provisions.
Building on the previous point, all compensation policies should include these clauses, which allow for the retention or recovery of compensation already paid in cases of misconduct, material errors or breaches of contract. These measures strengthen accountability and discourage unethical or excessively risky behavior, thus protecting the company and its shareholders.
In some regulated markets, publicly traded companies are required to include clawback stipulations in their compensation policies. These conditions even allow for the recovery of executive variable compensation when financial statements are restated, even if no misconduct occurred.
5. Actively involve shareholders.
Compensation policies must be reviewed by shareholders, who must have mechanisms to express their concerns and proposals to the board. In many publicly traded companies, this is achieved through “say on pay”, a nonbinding advisory vote that allows them to provide input on executive compensation. This practice, mandatory in some markets and recommended in others, reinforces transparency, accountability and the legitimacy of the decisions made, strengthening the compensation system.
6. Ensure transparency in disclosure.
Companies must communicate clearly regarding how executive compensation is calculated, approved and monitored. This includes detailing the amount and type of compensation, the criteria used for its evaluation and the degree of correlation between compensation practices and corporate performance. Clear communication not only ensures compliance with regulatory and corporate governance standards but also strengthens the confidence of investors, the market and the senior management itself in the long term.
7. Periodically evaluate the effectiveness of the compensation plan.
No plan should be considered static. It should be reviewed and adjusted continuously, taking into account changes in the environment, new business needs, trends and regulations. Use specific metrics such as pay-for-performance alignment, granted versus realized pay comparisons and peer group benchmarking, in line with international best practices. These evaluations strengthen transparency and ensure that the system continues to fulfill its strategic purpose.
Closing Thoughts
Compensation systems go far beyond rewarding results: They constitute a key element of corporate governance, ensuring both short- and long-term business sustainability. Their purpose is not merely to recognize goal achievement but also the way in which goals are achieved. This promotes integrity, responsibility and value creation. Companies can strengthen their legitimacy and build relationships of trust with all their stakeholders, ensuring conscious and sustainable growth.
