This is the first in a series of articles on the crucial role of boards of directors in actively supporting corporate transformation.
Three out of four corporate transformations fall short of their objectives. Yet failure is not inevitable. What often distinguishes success from stagnation is not strategy alone but whether leaders and key contributors are making their best effort and pulling in the same direction.
Boards of directors can improve the odds by designing incentive plans that tie executive rewards to the decision making, behavior, and accountability required for a successful transformation.
Why Boards Must Step Up
By transformation, we mean comprehensive, multiyear programs that change the face of a company. As transformations grow in numbers and importance, boards are playing a more active role in these high-stakes endeavors. For example, rather than simply overseeing management, they can collaborate in the design and execution of such elements of a transformation as incentive plans.
Most companies have short-term incentive plans (STIs) that typically reward annual financial performance. They also have long-term incentive plans (LTIs), such as stock options, that reward shareholder value creation over three to five years. But because transformations are so disruptive and taxing—they can make or break a company—they require a more targeted approach to structuring incentives.
To improve the odds of a transformation’s success, nearly all boards need to reconfigure their STIs and sometimes also fine-tune their LTIs. To generate speed and momentum, incentives should be forward-looking and directly linked to the specific goals of the transformation. Our experience with hundreds of transformations suggests that asking and answering seven questions can provide companies with helpful guidelines in reconfiguring their incentives.
1. Who Should Be Rewarded?
The most successful incentive programs reward transformation leaders at all levels, from the CEO to initiative and workstream leaders who meaningfully contribute to transformation outcomes. Depending on the size of the organization, this could be dozens or hundreds of employees. The size of their incentives depends on the significance of their contribution. This approach is more effective than a top-heavy incentive scheme at ensuring that both senior leadership and those closest to the work are aligned, engaged, and accountable.
2. What Should Be Rewarded?
At least half the short-term incentives should be directly linked to the goals of the transformation. The goals, in turn, should align with the signed-off run rate of the program results—that is, the recurring operating-profit contribution from completed initiatives. This keeps leaders focused on what really matters to the transformation’s success. Focusing on the run rate, rather than just historical results, helps drive both the ultimate outcome and the speed of getting there.
To complement the financial view, boards may also want to reward nonfinancial performance, such as collaboration and contributions to cultural change. Improvements in these areas can help the bottom line and build organizational capability. People need to work in new ways for a transformation to succeed, so rewarding them for behavioral changes helps create sustainable impact.
3. How Tough Should the Targets Be?
The STI targets should be ambitious but achievable. They should be more ambitious than the goals announced to investors and the public. They reward stretch performance, not just average or even above-average results. However, if the targets are too demanding, companies may lose the engagement of their people.
Target levels should be set on the basis of net rather than gross impact. All transformation programs face some leakage —the imperfect realization of projected financial improvements in the bottom line due to severance pay for laid-off employees, inflation, operational inefficiencies, and other factors. Therefore, incentive targets for gross impact should be set high enough to yield the targeted net impact, encouraging leaders to minimize leakage.
4. What’s the Right Balance?
Incentives should strike a balance between individual and team performance. For senior leaders, more of their reward should be tied to the overall success of the transformation. In contrast, incentives for leaders who oversee specific workstreams should be linked to their team’s results. This encourages accountability while also promoting collaboration across the organization.
5. What’s the Right Type of Reward?
Short-term incentives should typically be paid in cash. The simplicity of cash incentives helps clarify expectations and lets employees measure their progress in achieving transformation outcomes. The size of the reward should generally be 50% to 100% of the variable short-term compensation associated with the leader’s role. In some situations, companies with challenging targets have temporarily doubled the size of a leader’s STI to reward superior performance.
6. What’s the Right Duration and Payout Schedule?
Transformation-linked incentives should remain active throughout the entire program, often two to three years. To sustain engagement, organizations should implement annual payouts, triggered by the achievement of specific milestones and partial targets. This ensures that leaders stay focused on both incremental progress and final outcomes. The schedule may also differ by role type, allowing for more frequent payments tied to specific outcomes for more junior employees.
7. Should the Board Create a New Incentive or Adjust an Existing Plan?
Organizations usually realign their existing short-term incentive plans to reflect the transformation objectives. Often, the overall size of the STI is increased by up to 50% to reflect the importance of the transformation. Boards want to ensure that the STI will make a difference in performance at all levels of leadership.
Most transformations fail to fully achieve their goals. With so much at stake, boards must exercise their oversight responsibilities in order to improve the odds. Reconfiguring incentives is a great place to start.
