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Designed for Growth: Structuring Executive Compensation Programs to Drive Collective Ambition

In our People Fuel Growth study,' we explored what successful companies do to outgrow their Industry competitors, and we found a consistent pattern. In fact, people are the common piece that completes the puzzle. In a world more dependent on human capital than ever, people are the key to sustainable, profitable growth. The components of the model are clear and evident:

  • Collective Ambition: A singular vision, purpose and aspiration at the leadership team level focused on driving growth.
  • Customer Centricity: An intimate understanding of the customer; predicting customers' needs and What they value; identifying how a firm can uniquely deliver on those needs.
  • Collaboration: A focus on creating "collective genius" by leveraging diversity of skill sets and driving innovation at the intersection of organizational boundaries.
  • Design: Aligning the organization, culture, processes, and people programs to the growth goals of the firm.
  • Discipline: Building a systematic approach to deploy, manage, optimize, and track resources and talent.
  • Clarity: Making certain that each and every employee feels a part of the growth journey and knows their role in that journey.
  • Mindset and Action: Ensuring leaders have the conviction, resilience, and long-term vision to create the right cultural environment to foster growth.

What is Collective Ambition?

100% of our profiled companies said collective ambition was key to their growth trajectory

In determining what firms do to drive stellar growth, we found that all the companies we interviewed have "collective ambition." Collective ambition means that leaders are united under a singular vision, purpose, and aspiration. While our growth model is comprehensive and includes solutions for every tier of an organization, this element focuses on how growth is driven top-down through unified leadership.

The organization's leadership is responsible for centering on a collective ambition and then realizing it's growth goal through successfully utilizing its human capital. People fuel growth—and an organization's leadership is most effective when working together on how to best leverage it's talent.

Link to Executive Compensation

A study on high-performing companies by our colleague Bill O'Connor highlights one of the underlying themes of collective ambition: uniting leadership around a common goal allows them to best leverage their talent: As demonstrated on the following pages, high-performing companies unite leadership to drive collective performance through the unique design of their annual and long-term incentive plans.

High-performing companies unite leadership to drive collective performance through the unique design of their annual and long-term incentive plans.

Annual Incentive Plan Design

Performance Metrics

The most common practice among high-performing companies is to use one or two performance metrics in the annual incentive plan, with approximately 40% of high-performing companies in the sample using only one metric. The most common practice among average performers is to use three or more performance metrics. By using fewer metrics, the high-performing organizations drive performance in those one or two key areas most closely aligned with growth.

For high-performing companies, profit is often the only performance metric used in the annual incentive plan, which aligns all employees throughout the organization on a singular, critical metric. By contrast, average performing companies frequently pair profit with other performance metrics, creating an increased number of focus areas — some of which push and pull against each other.

The approach used by high-performing organizations creates an emphasis on rewarding corporate-wide, or collective, performance. At the same time, it de-emphasizes rewarding the achievement of individual or unique strategic goals that likely are influenced by a more limited number of individuals.

However, just because individual or strategic performance measures are not used in a company's annual incentive plan does not mean they are not used. Such measures are just used differently, often through an individual scorecard or dashboard, from which the executive's individual performance is assessed.

Performance Curve

It is common for high-performing companies to establish a maximum level of performance that is more challenging than that of average performers. In recognition of the more challenging maximum performance level, the high-performing organizations generally provide for a higher maximum award payout (as a percent of target) than standard market practice and average-performing companies. With respect to setting threshold levels of performance, there is little difference between high- and average-performing organizations. However, with respect to payouts, high-performing organizations provide a much lower payout (as a percent of target) for achieving threshold performance than average-performing companies. The high-performing organizations are effectively telling executives that they do not pay for achieving "minimum" performance

The more highly leveraged design adopted by high-performing companies can significantly drive incremental growth, pushing participants to drive performance to maximum levels in exchange for receiving an above-market award payout (as a percent of target). This pay for performance linkage is one tool used by high-performing organizations to drive incremental growth and align the organization.

Long-Term Incentive Plan Design

Long-Term Incentive Plan Vehicles

Time-vested restricted is viewed as an effective tool to retain executive talent due its low risk. However, it is generally not viewed as an effective mechanism to drive long-term value creation because is still valuable even without value creation and may not provide the appropriate incentive to grow share price. Stock options, in contrast, incent value creation, as they do not have value unless the share price increases above the exercise price. In addition, at grant, generally takes 2 to 4 stock options to equal the value of a share of restricted stock, which creates additional leverage for stock option recipients. As a result, this vehicle creates a win-win scenario for shareholders and participants by requiring increases in share price for the award to have value and providing leveraged award opportunities if that occurs. Furthermore, it aligns the executive team around value creation, and the execution of the strategy that leads to value creation.

Performance Metrics Used in Performance-based Long-term Incentive Plans

The prevalent practice among the high-performing organizations included in the study was to use only one performance metric in their long-term incentive program, compared to average-performing companies preferring to use at least two metrics. Selecting only one metric narrows the executives' focus around a single critical measure of performance to drive growth and return.

It was interesting to note that most of the high-performing companies used a different performance metric in their long-term incentive program. Some companies focused on profitability, while others focused on return. The unique approach used by the companies illustrates that the high-performing organizations selected the metric that they believed was most highly correlated with driving long-term growth and performance.

Use Total Shareholder Return

  • 33% Average Performing
  • 10% High Performing

Of the high-performing companies included in our sample with performance-based long-term incentive programs, only included relative or absolute total shareholder return ("TSR") as a performance metric. This compares to 33% of average-performing companies that use relative or absolute TSR as a performance metric.

We attribute the limited use of relative or absolute TSR for high-performing companies due to the desire to use performance metrics that are more controllable. Generally speaking, relative TSR can be subject to many outside influences that may not necessarily reflect company performance and management execution. using performance metrics that the executives can collectively drive, such as profitability or return, creates a singular vision focused on the input (vs. the result) and likely ties more closely to the company's core financial objectives.

Case Study

Let's examine how collective ambition is created in an apparel firm that participated in our study. This firm has an annual executive seminar that unites all its business leaders with industry pioneers. The purpose of this seminar is to generate insights on future industry trends. Leaders are then able to formulate a unified vision after actively discussing the State of the Industry.

Collective ambition also fueled by competitive, yet collaborative, leadership. The leadership team has a strong desire to be successful but is also aware that this occurs when members are able to work jointly. Thus, leaders ensure that goals and innovations are cascaded throughout the organization and equally shared throughout different segments. The CEO of the organization ensures that team members are centered on results and ensures that all decisions have a lasting impact on the organization. Finally, collective ambition realized by the leaders instilling throughout the organization an attitude of working together to achieve the goals. While leadership sets the vision and actual goals, the leaders make sure that the rest of the organization follows through with their vision.

Finally, collective ambition is realized by the leaders instilling throughout the organization an attitude of working together to achieve the goals.

Realizing Collective Ambition in Your Organization

Collective ambition is entirely dependent on leaders working together to create a singular vision, purpose, and aspiration. In order to ensure collective ambition, it is essential for leaders to review the organization's mission and growth plan regularly. Organizations that participated in our study held meetings to discuss their growth plan at least once a year.

Likewise, high-growth organizations have regular cadence for their senior meetings. Meeting on at least a monthly basis ensures that business leaders are working in unison to accomplish their goals. Finally, achieving collective ambition requires that goals are tied to concrete measures. Although organizations vary on what measures they prefer, we found that measures of profitability and return are most common in our prof led high-growth organizations.

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