Designing Executive Compensation Plans in New Nuclear Build Programs
Designing compensation programs that drive highest safety standards, retain and motivate key executive talent, while simultaneously maximizing shareholder value, is a challenge most companies face, and this is extremely prominent in the new nuclear build where stakes are exponentially higher due to safety and cost impacts. Responsibility for walking this precarious line falls to both members of the management team and of the compensation committee of Boards of Directors (Compensation Committees). Due to a volatile market in the energy sector, structuring pay packages can be a daunting task. The goal is to structure pay packages that align with the programs’ strategy and to avoid an avalanche of key executive departures, all while facing the ire of third-party shareholder advisors, the media, and increasing market pressures.
To do that, companies must ensure compensation programs are reasonable and specifically tailored to their organizations and operating environments. This can be accomplished by analyzing the competitiveness of the arrangements (as compared to those offered by companies in its peer group), and the likelihood that executives will be sufficiently motivated in both the short and long-term.
Properly structured incentive compensation arrangements are effective in retaining and motivating executives over different periods. Annual incentive plans (Short-term incentives – STI) measure short-term performance (generally, over one year) and long-term incentive plans (LTIP) measure performance over longer multi-year periods. Understanding the executive pay from the global market perspective and at the same time bringing it home and getting a good insight of how local competitors compensate their executives is critical to the success of designing executive compensation plans in New Nuclear Build Programs. Companies tend to link compensation to corporate objectives in the form of STI and LTIP; and traditionally, these bonuses have been linked to factors like profitability and revenue growth. But in the Nuclear sector need 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, therefore EHS component in their executive compensation structure is a must.
Economics Of Nuclear Power Plants:
The costs for nuclear power plants are driven primarily by the upfront cost of capital associated with construction. The construction of a new nuclear power plant involves risk in construction delays, public opposition, and changes in the regulatory environment, all of which could lead to significant cost overruns and adversely affect the profitability of a project. Even though the fuel costs of a nuclear plant are fairly low, these upfront costs associated with construction and financing tend to dominate the ultimate cost of nuclear power and make it significantly more expensive than fossil fuel power. With this in mind, the future operating model must be contextualized as early as possible. Knowing economics of nuclear power plants and how to target operating model will balance investment in Safety, Revenue and Gross Margin set the base for properly structured incentive compensation arrangements.
Most Nuclear Power Plants come in one of three groups.
A) Companies, where cost is central to their vision, will increase the importance of the maintenance process (scheduling, outage management, and maintenance) in the organizational design.
B) Companies emphasizing high system availability will increase the importance of system engineering in the organizational design.
C) Companies with a conservative approach to operations will increase the importance of quality assurance, nuclear safety review, and engineering in the organizational design.
Developing the Executive Compensation Strategy
The compensation strategy needs to support the business strategy. Besides, the strategy should be suitably selected to endorse its long-term success in its implementation and execution. The design of the compensation plan should also be properly laid out to minimize the likelihood of failure. The development of the plans should be such that the plans can achieve the programs’ core objectives, the plans are effectively reinforced on an annual through statements from the participants, and that the plans are competitive in the market. The design should also ensure that the plans are suitable rewards for the corresponding performance, can be regularly evaluated in the medium-term and they are easy to convey to any incoming participant (Reilly & Lindeman, 2017). The compensation plans should also consider the structure of the workforce and its demographics, and the tax and accounting policies associated with the plans (HR Knowledge Center, 2017).
There are four crucial steps that should be followed in designing the compensation plans.
The steps are as follows:
A. Strategic Alignment
At this stage, the compensation team should assess the organization’s strategy so that the reward plans are developed to augment the intricate, capital-intensive and long-term objectives of the entity. The plans should also integrate the goals of all the business units, and incorporate the comprehensive long-term and short-term reward programs. Further, this step incorporates developing expatriate programs designed to attract universal managerial placements (Pojasek, 2005).
In the conclusion of this step, the compensation team develops a mission and vision statement, and core values that will guide the design of the entity’s compensation plan in line with the firm’s counterparts. The team should determine the objectives of the plan and how it influences the success of the program, and determine the metrics to measure the attainment of the objectives (Pojasek, 2005).
B. Internal and External Assessments
The internal assessment entails the evaluation of the historical, current and intended objectives of the compensation plan. It also incorporates an analysis of the internal processes and the knowledge and competencies that will be instrumental in the attainment of the goals of the compensation plan. An assessment of the LTIP practices is also carried out to determine their practicability to the program. Also, the compensation team evaluates the perspectives of the internal stakeholders (target employees) on the achievement of the set goals.
The external evaluation entails the definition of the entity’s peer group and its competitive appraisal of the reward mechanisms. It also entails an assessment of the perspectives of the external stakeholders (shareholders, clients, suppliers, society, and regulators) on the attainment of the goals. Upon the assessment, the performance measures are carefully chosen and adjusted, and the prospective plan results are modeled against the past performance and the performance of the peer organizations. The entity also carries out compensation surveys to gather expectations and best practices in the sector. Lastly, the committee balances the projected plan outflows versus the earnings outlooks of the program (Pojasek, 2005).
C. Compliance Assessment
This entails the evaluation of all remuneration-related risks and developing management and mitigation mechanisms for them. It also incorporates an analysis of the perspectives from the key stakeholders of the organization and communicating the compensation discussion and analysis, and disclosures. Also, at this step, the compensation team assesses and aligns the compensation plans with the best practices in governance for the sector (Pojasek, 2005).
D. Developing Tailored Solutions
In as much as there are various approaches for designing compensation plans, they all break down into a small number of common overall methods that answer the following five questions:
a) How Much to Pay? Or what is the appropriate pay positioning in the market?
Market position is an element-specific to each organization based on the strategy, target operating model, competitive landscape, and availability of talent, among others. Deciding on “at-risk” earnings within packages will be essential as this is based on the Goldilocks principle. Low variability and too short-term will allow for freeloaders, and high variability with too long-term will come across as difficult to attain. The compensation programs need to incorporate a suitable balance for the fixed remuneration packs, the STI and the LTIP to augment their suitability in both the short- and the long-term.
This calls for a shift from the traditional compensation mechanisms towards dynamic structures that incorporate both the strategic metrics and non-traditional compensation methodologies on the accomplishment of the programs’ objectives. Thus, the remuneration approaches need to focus on reinforcing the mechanisms used in setting targets for the STI benchmarks to enhance the alignment of the remuneration package and the executives’ performance. The LTIP mechanisms should have higher weights on equity other than cash incentives (where a program has the equity incentive as an option), to build a sense of belongingness on the executives (Ernst and Young, 2016). In the absence of the equity incentives, the LTIP should be cash-based with mandatory rollover. A typical mix that would work well is 40% of fixed pay, 30% STI and 30% LTIP.
As a general best practice, the compensation packages also need to be reviewed regularly to warrant their efficacy in promoting the intended purpose and supporting the performance of the programs. This will ensure that the reward plans are suitable for targeted participants, instead of having a one-size-fits-all approach. Also, the reviews will help the programs to assess the costs versus benefits of the programs’ compensation approaches through the analysis of both the monetary and the non-monetary executive benefits. The goal is to ensure budgetary optimization, where there is maximization in the utilization of all the funds used in developing the engagements with the executives (Ernst and Young, 2016). It will also ensure that the compensation plans balance competitiveness and affordability because committing to unaffordable plans will be detrimental to the long-term viability of the programs.
b) Who to Pay?
The questions relevant to this aspect are;
a) How to create differentiation among executives to drive performance and engagement?
b) How to segment the top layer of the organization to impact behavior change through rewards.
It all starts by defining the critical jobs based on the framework that encompasses the following criteria:
- Criticality to business success: Jobs that contribute to the long-term strategic success of the organization (such as regulatory, safety, milestones, new capabilities, strategy, revenue, and risk).
- And the scarcity of skill set: Jobs difficult to source candidates and/or training employees for the job requires significant lead time.
The market practice is to provide STI to both Executives/Senior Management and employees in critical jobs, while LTIP is exclusive to the Executives in critical jobs, key talent and at times the members of the board. The LTIP acts as a mechanism to keep top talent and reduce the movement of the core talent to the programs’ competitors. The programs also get an opportunity to share their perennial success with the crucial people, who also commit to the long-term success of the programs. It is also an opportunity for the executives to differ their earnings to the future years, acting as a supplement to their qualified retirement plans (Reilly & Lindeman, 2017).
c) How to Pay? What vehicles are available to compensate executives?
Given that most of the New Nuclear Build Programs are in emerging economies and designed for a significant population of ex-pat employees it will be to a large extent the cash-based plans (performance unit plans and value sharing) (Reilly & Lindeman, 2017). This is because the share plans or equity-based plans are not likely to be an option, if the company is not publicly traded and is instead privately owned, and the owners are unwilling to dilute their ownership with any REUs (restricted equity units). The cash-based plans will be effective for the nuclear build programs because they can be customized to fit definite long-term strategic objectives, thus providing a solid connection between compensation and performance. They will also be suitable for the programs because the executives will be able to manage and better their performance independently (U.S. Merit Systems Protection Board, 2006).
Besides the cash-based LTIP, the programs should incorporate recognition in the incentives and exercise fairness to achieve the psychological satisfaction of the participants (Pricewaterhouse Coopers, 2012). A part of the recognition package, less than 5%, should consist of perquisites as a symbol to recognize the value of the participants to the programs, their exceptional contributions and other exclusive conditions of the executives, which are unavailable to the rest of the employees (Center on Executive Compensation, 2017)
d) What to Pay For?
As the Nuclear Programs mature and change over time, it is important that Executive Compensation Strategy evolves with it and adjusts for the expected changes on the ground ahead of time. The compensation plans for the programs will need to reflect rewards for sustainability in both the financial and the non-financial performance metrics. The financial performance can be measured during the construction and build phase clearly accent, where the focus is on the achievement of milestones and the internal rate of return (IRR). This is because the organization’s approach to operations shift will be towards the supply of consistent baseload electricity, EBITDA Growth, and NAV Growth as it typically creates the best sense of alignment with the financial plan and outlook. LTIP should be milestone vesting with cash payments based upon the completion of the milestone according to the performance measures. The target levels of the award are set to ensure that the plan is self-funded from realized savings, which creates a positive impact on the bottom line while meeting EHS targets.
The non-financial based rewards include; environmental protection, safety and proliferation resistance & physical protection, which are EHS elements embedded throughout the lifespan of the Nuclear Program. This is an important aspect for the nuclear build programs to ensure that the executives are not chasing after generating humongous amounts of profits at the expense of the environment, the wellness of the other employees, and the entity’s brand and reputation, and the organization’s survival (Busick, 2015; Zou & Sunindijo, 2015). Thus, for the New Nuclear Build Programs, there is a need to embed the compensation plans of the executives with the corporate sustainability of the projects, where EHS standards are embraced. While agency costs are valuable to the shareholders, sustainable activities and executive compensation attached to EHS sustainability metrics are also likely to be of benefit in creating the value of the organizations also (Hong, Li, & Minor, 2015; Nicolăescu, Alpopi, & Zaharia, 2015).
e) When to Pay?
Since the objectives of New Nuclear Build Programs are discrete milestones, the performance period for each milestone is aligned with the respective milestone’s timeline. To drive the corporate behavior, each selected measure will be evaluated over the period required for 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 retention impact of incentives as well as full accountability, incentives should have a portion of incentive award deferred over time with the potential inclusion of performance-based vesting criteria which considers how business results in an award year develop over a multi-year period (for example, the re-evaluation of the performance of 2017 in 2020).
However, the compensation plans with the rolling over option should be appropriately designed to provide a vivid payback and optimization of the cash flows. The ROI of the plans should be justified so that the programs can select the deferral options with benefits and opting for annual reward plans when the costs of deferral are unsuitable (Pricewaterhouse Coopers, 2012).
The long-term goal of the tailored solutions should be a compensation plan that reflects an organizational culture that backs the pay for performance mechanism, a stringent performance assessment system, and fairness through checks and balances on the remuneration system. Therefore, the New Nuclear Build Programs require making a considerable investment of their resources (time and money) to build a holistic compensation plan that relates to the strategic goals of the entity (U.S. Merit Systems Protection Board, 2006).
E. Showing how the Tailored Solutions Create Value for the Organization
This entails developing a hierarchy of the balanced scorecard perspectives (financial and market, customers and other stakeholders, organizational effectiveness, and learning and growth perspectives) and linking them to the performance indicators of the compensation plan. For instance, concerning the financial and market perspective, the compensation metrics could be matched with an improvement on the assets’ utilization, increase in the value of the shareholders’ wealth, reduced operating costs, and improved branding. Regarding the customer and other stakeholder perspectives, the reward measures could be linked with satisfied suppliers and customers, improved brand image, and satisfied employees. The performance measures concerning the organizational effectiveness perspective could be linked to waste reduction, improved productivity, lower number of accidents, and lower emissions. The reward metrics concerning the learning and growth perspective could be associated with improved work practices and improved the general performance of the employees. The process provides a ground to justify the reward plan based on the value creation to the entity (Pojasek, 2005).
Driving a top-performing business requires a more competitive construct for executive management compensation made up of the current year and also long-term forward-looking rewards. More importantly, the packages offered to the executive management population have to be attractive to top-performing candidate pool, and the packages need to encourage retention of employees in mission-critical jobs and align their interests and performance with the performance of the organization and the interests of the key stakeholders and owners.
A significant part of executive management compensation should be delivered through LTIPs to drive the longer-term business plans and encourage the right behaviors. Given the aspirational goals of New Nuclear Build Programs, compensation needs to mature beyond the one-year plan and take a more balanced, longer-term approach to deliver greater stakeholder value. The development of holistic LTIP yields significantly greater results and a higher return on investment than a one-dimensional incentive focused on retention or engagement alone. The organizations that successfully implemented LTIP have experienced the below benefits post-implementation:
- Stronger employee value proposition, leading to increased retention and reduction of operational risk and recruitment costs associated with the loss and replacement of key executives/managers.
- Greater ability to attract key talent to the organization.
- Stronger development of leadership succession pipeline as the longer tenure of executives allows for more developed succession programs.
- Increased alignment between management and shareholders.
- Greater focus on the achievement of key corporate and business unit KPIs/objectives.
- Greater risk-adjusted return, revenue, and profit margin.
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