This post was co-authored by Bertha Masuda of Semler Brossy and Travis Harms, bringing together complementary expertise in executive compensation strategy and valuation-centered business advice. Bertha is a Managing Director at Semler Brossy, a leading independent executive compensation and governance consulting firm known for its thoughtful, partnership-driven approach to helping boards and management teams tackle complex pay and talent challenge. We are grateful for this collaborative co-authorship and the valuable insights it brings to family business leaders navigating compensation in volatile economic times.

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Introduction

Macro-economic volatility has put pressure on compensation programs that depend on accurate goal-setting and stable growth, affecting executive morale and jeopardizing talent retention. Ultimately, the family-owned companies that best weather this uncertainty consider pay adjustments within the broader context of family shareholder and business needs.

Consider Family Businesses’ Unique Structural Factors When Navigating Volatility

Compared to publicly held companies, family businesses have greater flexibility in how they handle business volatility and its impact on compensation plans and payouts. This is due, in large part, to the following key factors:

1. Longer-term outlook. Generally, family businesses have a long-term performance horizon and the fortitude and resources to weather short-term business volatility. Investing in a robust, sustainable talent pipeline, even in uncertain times, is key to protecting the company’s legacy and its positive institutional culture.
2. Greater degree of freedom in decision-making. Being removed from proxy advisory oversight, Say-On-Pay votes, and externally mandated disclosure requirements offers family companies more latitude to make compensation decisions that align with their long-term strategic outlook, even if they diverge from expected governance orthodoxy expected of public companies.

This does not mean family businesses are immune to volatility. But knowing the unique contours of the market is crucial to understanding which levers boards have to pull to manage the macroeconomic climate.

Assess the Effects of Volatility on Business Value and Talent Concerns

While it may be tempting to jump immediately to discussions about changes or adjustments to compensation programs or payouts, it is worthwhile to reflect on how uncertainty affects the business and talent. Understanding the reasons for performance and payout volatility is a critical step to ensure the appropriate course of action.

• Diagnose the specific effects of volatility. Do the events creating volatility represent a temporary deviation or a structural change in the business?
  • If short-term in nature, family businesses have flexibility to creatively address specific pay and retention issues to bridge any short-term gaps such as providing a special one-time key metric incentive when external factors eliminate the regular bonus payout.
  • Conversely, if volatility signals a fundamental shift in outlook and risk, a review and a potential reset of company strategy and compensation may be required. For some businesses, volatility is not an unwelcome guest and can create opportunities to build structural advantages that expand available markets and the talent pool. For example, there may be an opportunity for bold firms to invest in growth when the competition retrenches.
• Evaluate the compensation program’s competitiveness and historical payout history. Benchmark current and historical average pay levels to ensure competitive positioning against the market. The mere fact that an incentive program isn’t paying out at or above target currently is not enough to make an adjustment – context matters. For example, a single down year – when longer-term incentive averages remain competitive – may indicate that the program is performing as intended.
• Identify key talent and any associated retention risks. In rapidly changing times, it is important to understand which employees are the highest priority for retention. The talent assessment includes identifying which people:
  • Are most essential to steward the company through current uncertainty
  • Could step up in role in the event of an emergency
  • Represent the future leadership of the company (succession planning)

Immediate Pay Actions In the Event of Short-Term Volatility/Temporary Setbacks

If uncertainty is considered temporary, family businesses can consider the following short-term pay modifications. These changes can be one-time in nature or only discontinued once business-as-usual resumes.

• Consider a special one-time adjustment. If considering a “special” adjustment to payouts, the compensation committee should consider crafting a disciplined adjustment framework in advance. Making sure there are guidelines and that it’s an exception and not an annual occurrence prevents an “entitlement” mentality. Building a strong adjustment framework can help:
  • Align employees on the path forward
  • Tie adjustments to concrete metrics of success
  • Communicate rationale behind proposed changes to the family in advance
• Modify existing compensation programs. Unlike public companies, which tend to be boxed in by peer-company incentive practices and wary of negative proxy-advisor reactions, family businesses have more flexibility to add or adjust incentive metrics or structure one-time special incentives to focus and align executives on key metrics and operations to steward companies through short-term upheavals. For example, if the company assumed additional leverage beyond the family’s typical comfort level, consider tying part of the incentive compensation to deleveraging milestones or credit-quality improvement.
• Focus on key talent. By appropriately compensating and motivating key employees, companies can ensure stability in the most vital areas. Adjust salaries or, if necessary, consider a one-time retention bonus to mitigate the risk of losing those employees who are too crucial to long-term growth. Note, however, that any adjustments or bonuses should be highly-targeted in scope and backed by a clear rationale to prevent feelings of animosity or entitlement by the broader employee base.

Volatility May Offer Opportunities for Growth And Require More Material Long-term Changes To Pay Approach

Periods of uncertainty can be an opportune time to think broadly about long-term business strategy and to align compensation philosophy and programs with company goals. We have outlined more enduring pay changes that family businesses can consider below.

• Update compensation philosophy, pay positioning, and mix. Family businesses tend to follow legacy practice in their pay positioning and pay mix. It is worthwhile to evaluate whether the status quo remains appropriate given current strategic imperatives and projected growth prospects. For example, companies that have historically paid high bonuses to compensate for low salaries may need to reconsider the pay mix and salary positioning if business volatility is expected to persist.
• Consider a retention hook. If not already in place, family businesses can consider granting phantom or real equity to promote a long-term ownership mentality among executives. A deferred compensation plan is another, often lower-risk, pay instrument that provides future security. The competitive pay assessment will determine whether these longer-term components are an incremental benefit or if rebalancing pay components is appropriate.
• Communicate the broader employee value proposition before reflexively raising pay. Compensation is important, yet only one element of a company’s broader value proposition for employees. Promoting and upholding the company’s mission, creating opportunities for career development, and fostering a positive culture are all crucial, and far less expensive, ways to attract and retain talent long-term.

Shareholder Considerations Related to Compensation Adjustments

Family shareholders have a responsibility to protect the organization’s sustainability and are entitled to a fair and reasonable return. Any modifications to compensation programs should be consistent with these commitments. It may be prudent to consider “catch-up” provisions when volatility has subsided, a cap on payouts, or shifting to deferred compensation/extended vesting periods instead of immediate cash bonuses.

Any proposed changes to management compensation should align with family shareholder requirements. In times of uncertainty, it is important to understand whether the family prefers to pull back on investment and preserve shareholder distributions, or to forego shareholder distributions in favor of continued investment. The family’s preference regarding the approach to distributions should be consistent with any proposed compensation actions. Consider, too, the correlation between compensation decisions and any distribution actions. The combined actions should be appropriate for the circumstances and maintain alignment between management’s incentives and the family’s total returns.

When navigating shifts in executive compensation, clear communication with family shareholders is essential. Family shareholders should have insight and transparency into the rationale for changes to compensation programs and understand how proposed actions enhance shareholder value. The planning process should intentionally include opportunities for shareholder engagement and feedback before decisions are finalized, every year but this is especially true in a rough year.

Conclusion

Family businesses have a stewardship advantage worth leaning into. A long-term orientation, paired with patient family capital, offer competitive advantages during turbulent periods. Those companies with well-articulated principles underpinning their compensation plans will be better able to navigate uncertainty more effectively and communicate the rationale behind any changes to those plans with clarity. Ultimately, family businesses can use today’s challenges to strengthen, rather than abandon, their core business ,talent and compensation principles.