Retention, Performance, and Mission: Long-Term Incentives in Tax-Exempt Organizations

Jake: We continue our series on tax-exempt organizations with a deeper look at long-term incentive design. Mark and Aalap are joined by Pearl Meyer principal Tim Dupuis, who advises boards and senior management teams across tax-exempt organizations, and other industries, on executive pay competitiveness and annual and long-term incentive programs.

Together, they discuss when a long-term incentive actually makes sense, how organizations can benchmark opportunities when market data are limited, and why effective design starts with the business and talent problem, rather than simply following market prevalence. They also explore how tax-exempt organizations can balance retention, financial sustainability, and mission-based performance when building a long-term incentive program that fits their unique circumstances. Let's listen in.

Aalap: Hey, Tim, it's really great for you to be here. We had a very engaging conversation with Alexander the other day on tax-exempt organizations, and we really appreciate you taking the time to do a bit of a deeper dive for us.

Tim: Great. Looking forward to the chat, and hopefully we can provide some deeper context as it relates to long-term incentive programs within the tax-exempt space.

Mark: Yeah, that's great, Tim. Thanks. We focused mostly on tax-exempt healthcare, but I understand you work in more varied industries that just happen to be tax-exempt. Maybe you could talk to us a little bit and kick it off with, when does it make sense to have a long-term incentive for tax-exempt and when might an organization might be better off without one?

Tim: Sure. I would say typically when I'm working with a client the first thing I want to understand is, what problem are we trying to solve when we're thinking about long-term incentives? Is there a retention issue? And if there is, what is the purpose of the retention issue? Are we trying to retain executives because the organization is going through some sort of leadership transition or a difficult business cycle that maybe is being driven by a change in external market factors, and we want executives or key talent to stick around through that transformation?

Or is the retention concern stemming from the fact that the company is either losing executives or having difficulty attracting executives from similar organizations where a key component of that organization's compensation package is tied to long-term incentive levels, and therefore we're ultimately finding that our total compensation falls below market-competitive levels?

Aalap: Tim, I completely understand the need to do it when there are retention concerns, but I would imagine some organizations want to do it for other reasons. Would that be the case? 

Tim: Outside of retention, a lot of times when we're implementing long-term incentive plans, it's really to introduce another vehicle that focuses on establishing a longer-term performance orientation to its overall executive compensation program. Maybe because their business strategy is changing or they've identified certain mission-based or operational weaknesses in their business, and there is now a need to focus executives in certain areas to enhance overall performance of the organization.

Taking one step back, thinking about Mark's first question related to when a long-term incentive program may not be appropriate. I would say it’s one of the traps that some of our clients fall into. It’s really focusing on the prevalence of long-term incentives and them coming to us and saying, "Hey, most of the companies that we're competing with, or a good chunk of the companies we're competing with, tend to have a long-term incentive plan in place, and therefore we think they should as well."

My response to that question is typically that while market practices should certainly inform a decision. If we're going to implement a long-term incentive program, it really has to meet a business need. Because I work with many organizations that have competitive base salaries, meaningful annual incentives, and potentially even deferred compensation programs or robust retirement benefit plans in place, where the current compensation package, or total compensation package as you roll it up, is already competitive.

And in those cases, implementing a long-term incentive plan may not always be the best approach. It can certainly add complexity to the overall compensation plan. And if a company is, for the first time, introducing a long-term incentive plan and those participants maybe have not participated in a plan before, they may not fully understand the full compensation value of that plan. And so, we may not always get the bang for our buck that we're using to implement such a plan.

Aalap: And Tim, do you find that organizations spend time and resources, when they do want to do a program like this, in fleshing out a communications plan to really deal with that issue? Or does that not typically happen?

Tim: Yes. When my clients introduce a long-term incentive plan, the ones where it works well and actually drives long-term results, there is a robust communication plan in process.

So we're working with our colleagues here at Pearl Meyer, as well as internal communications people at our client, to identify appropriate FAQs or formal documentation that can be provided to those new participants. That's really explaining, "Here's what the plan is, here's why we're implementing the plan, and here's what it means to you from a compensation standpoint."

Aalap: Once an organization decides it needs to do an LTI program or wants to do an LTI program, how do you determine the appropriate compensation opportunity?

Tim: Yeah, Aalap, this is where the work gets more interesting because unlike base salaries or annual incentives, there often isn't one clean data set that we can present to the client and say, "Here's the market."

I've been recently working with a large health plan, for example, where our labor market for talent is fairly broad. We come to them with market data from other tax-exempt health organizations, but we're also coming to them with broader healthcare data and even broader general industry data, which often includes data from publicly traded companies.

None of these data sources is perfect on its own. And so what we really do is try and triangulate the data so that we can begin to tell a story. We don't necessarily expect every data source to answer the same question.

The nonprofit health plan data likely gives us the best organizational comparability, but the broader data that may include publicly traded companies can tell me a little bit something different about the overall broad labor market for talent and gives a completely different perspective on the total compensation that is provided between those two different types of organizations.

One of the things when looking at market data is that organizational comparability and talent market comparability are generally not the same thing. Tax-exempt organizations and public or large for-profit organizations tend not to just have total compensation levels from a market perspective, but they also tend to have very different pay mixes.

Tax-exempt organizations often provide lower levels of long-term incentives but tend to be more generous when it comes to other ancillary benefits or retirement benefits. While in a large for-profit or publicly traded company that may exist within their labor market for talent, the vast majority of their executive compensation program is typically tied to those long-term incentives.

Mark: That retirement issue is really interesting. I've always thought of retirement as a long-term incentive because if you stick around, you're going to get it. So it's actually more stable, if you will, than a restricted stock grant, for example, in a for-profit because you don't necessarily have the stock price variability. How do you talk to your clients about that?

Tim: Yeah, that's a really great question. And I think it's important to understand that a dollar of public company equity isn't necessarily economically identical to a dollar of retirement benefit or a dollar of cash LTI at a nonprofit.

Public company executives often have ownership requirements that they have to meet, so they have to hold a certain level of equity. They're subject to that underlying stock price movement, which provides more volatility in their actual benefit that is potentially earned. And they have liquidity challenges in many designs where it's not always easy for them to sell that equity to put in their pocket.

Whereas in a non-profit program, such as a retirement program or a cash-based program, there's typically less upside and downside risk. So the volatility in payouts can be slightly more forecasted or expected, and they often have the ability to earn that award and put it in their pocket quicker than an executive in a publicly traded company where they're primarily receiving stock.

Aalap: Yeah, and Tim, I think at the heart of any effective long-term incentive program are the metrics. When you think about what are appropriate metrics for tax-exempt organizations, what really comes to mind?

Tim: Yeah, and you're spot on. We can talk about the appropriateness of a long-term incentive program, the appropriateness of a vehicle, but ultimately, what you are measuring is what most often correlates with the success of a long-term incentive program working. When it comes to tax-exempt organizations, in my experience, the most effective plans have a pretty strong balance of financial sustainability metrics as well as mission or strategic-based outcomes. Whereas in a for-profit or publicly traded company, primarily, although the landscape is shifting a little bit, the vast majority of any long-term award opportunity is going to be tied to the financial side of that coin.

Mark: What about those mission-based? What does that look like?

Tim: Yeah, sticking with my health plan example, I was recently working with an organization that was struggling in a couple of different areas. One was employee satisfaction, and one was customer engagement.

Those two areas in isolation are pretty hard to change in a meaningful way in a short period of time. And so, we've worked with that organization to develop metrics that can be achieved and moved towards more appropriate levels in the long term. So, employee satisfaction scores—a lot of my clients, especially the more complex ones, annually give employee satisfaction surveys—and so setting goals around improvement in that area.

From the customer satisfaction or engagement side, we see a lot of metrics that involve quality of care. We may see STARS metrics in that area. We may see affordability of care metrics put in that area. To me, the most important part is not necessarily just looking at what other companies are doing in your space, but how are we aligning those metrics with the overall long-term business plan of the organization we're working with?

Mark: That's good stuff. We could probably talk forever about the various different nonfinancial, mission-based goals. And I think a lot of organizations get interested in that because you can mix what does good looks like over the long term in terms of achievement of that mission, while at the same time locking people down from a retention perspective. Good stuff. Tim, this has been a great conversation. Really appreciate having you on today.

Tim: Great. Happy to be here.

Aalap: Tim, thank you again, and we'll get you back on soon. Take care.

Tim: Sounds good. Talk to you guys soon.

Jake: Our thanks to Tim for helping us to understand LTI considerations for tax-exempt organizations, and the balance between financial sustainability and mission outcomes. To close out our tax-exempt series in our next episode, both Tim and Alexander will return for a wide-ranging discussion around goal setting and related metrics, I hope you'll join us.

In the meantime, you can find all of our Unscripted episodes on Spotify, Apple Podcasts, pearlmeyer.com, or wherever you get your podcasts. Thanks as always for listening, and we'll meet you back here next week.