NACUBO

My NacuboWhy Join: Benefits of Membership

E-mail:   Password:   

 Remember Me? | Forgot password? | Need an online account?

Business and Policy Areas
Business and Policy Areas
Loading

Long-Term Awards in Higher Education

May 10, 2016

By Michael O’Malley and Jason Adwin

Many colleges and universities are dealing with reforms that take several years to complete as planned. Indeed, one of the great benefits of nonprofit organizations is their freedom from the quarterly vice of earnings reports and their ability to think about long-term objectives. And yet, conspicuously, the compensation practices in these institutions do not include programs that align rewards with long-term purposes and strategies.

Although performance factors can be attached to deferred compensation plans, these plans are used mostly to help high earners who have IRS limitations on annual retirement savings make up for that loss. Section 457(f) plans, which are also known as top-hat plans, have no limits on amounts. However, they do have eligibility requirements that restrict participation and therefore might exclude from an incentive plan people the institution would like to include. Unless structured appropriately, these plans also might be subject to onerous ERISA reporting rules.

A New World in Higher Education 

Given the new competitive environment in higher education, long-range thinking is more essential than ever. College and university five-year plans, their 2020 goals, have real consequences for their economic health and survival. A compensation plan that requires the careful monitoring of strategically oriented results over time is one way to communicate long-term imperatives and underscore the seriousness of making or missing organizational goals.

It may be that nonprofits have eschewed long-term incentive plans for fear the programs would be perceived as unreasonable by the IRS or contrary to the nonprofit purposes of the organization. However, these plans are designed to facilitate the provision of more or improved services and benefits at costs commensurate with the value added.

The threats that colleges and universities confront cannot be solved by the short-term cost-cutting tactics and tuition increases that were relied upon in the past. These once-effective solutions to fragile financials are now insufficient remedies. The problems faced by higher education are too large and the resources too limited to consider anything less than transformation and long-term change.

In addition, as David Trainor, vice president of human resources at Boston College, astutely points out, all of these threats now occur within an environment of heightened scrutiny from state and government officials as well as alumni and sundry special-interest groups. This is all new terrain for institutions that, until recently, had economic and demographic winds to their backs. Even well-resourced institutions will have to examine their long-term outlook; rethink their choices; and, if necessary, reinvent themselves. The introduction of a long-term performance plan consolidates opinion about the direction of the institution, fixes accountabilities, and establishes standards of achievement. We suggest that higher education should take a logical step and implement new compensation plans that delineate college and university aspirations, focus institutionwide attention on what is most important, and recognize executives who meet the myriad of challenges while preserving the institution's mission as a quality provider of a public good.

Small Steps Toward the Future

More executives of nonprofits are coming from the world of business and more directors are coming from major corporations as opposed to small local businesses. Surveys show that about 20 percent of college and university presidents have spent significant time in the private sector. Indeed, one import from the business world we have observed based on our surveys is the incidence of annual bonuses among nonprofits. The prevalence of annual bonuses has increased from approximately 10 percent a decade ago to 20 to 30 percent today. The heightened familiarity of incentive plans among board members and executives, coupled with institutions' quest for improved efficiencies and the more judicious use of capital, has increased the use of pay at risk.

To be clear, although we view the transfer of practices from commercial enterprises to nonprofits as a favorable trend, we caution against the presumption that nonprofits can be run like businesses. The missions, capital structures, risk-return profiles, diversity of revenue channels, and other elements are different, and practices borrowed from for-profit corporations simply cannot be implemented in the same way in higher education without detriment.

We have seen growing sophistication and precision in the use of short-term incentives in academia. A plan now under consideration at Cornell University is one example. The plan is to introduce a weighted, goal-based incentive that ties the pay of covered executives to the achievement of specific university priorities. We suggest that a natural extension might involve the subsequent introduction of a long-term incentive as a companion plan.

Whereas most of what must occur in the short term concerns operational improvements, these improvements are made in the service of goals that orient the institution toward a more promising future. For example, the retention of students has become a priority in many colleges and universities. Setting a sound long-term retention goal requires organizations to make changes in the short run. An annual plan, therefore, might include new student housing arrangements, a revised freshman curriculum, new onboarding measures, closer scrutiny of student selection criteria, the addition of counselors, new teaching formats, and additional programming for freshman.

Long-Term Compensation

Many leaders and trustees in higher education do not realize that long-term compensation plans exist for non-stock organizations. These plans historically have been used for privately held companies. However, with the neutralization of tax benefits among executive plans in the for-profit sectors, they are growing in popularity there, too. Nonprofits typically have not realized that these programs are equally available to them. 

The most common plans are variations of performance-unit plans (the variations are due to different combinations of the number of units and the price of the units). We will describe a plan in which a fixed amount of units is allocated and the value of the units changes over time based on organizational performance. Although translating cash into unit shares is not a necessary step, it is one we advise for two reasons: 1) pseudo-stock better signifies the creation of organizational value to the communities served-value the institution is willing to share if goals are satisfied; and 2) the printed units are tangible, visible reminders of what the organization is trying to achieve.

Allison Vaillancourt, vice president of human resources and institutional effectiveness at the University of Arizona, rightly notes that long-term plans have little chance of institutional acceptance if they are introduced as "add-ons" to other compensation, and if the people who are working tirelessly outside the plan are not duly recognized for their contributions. These plans, therefore, are intended as complements to total compensation. Base salaries either are lowered or held in check with the intention that the college or university would provide incentive amounts that would raise compensation to competitive levels for competent performance and to levels beyond that for exemplary performance.

The employees included in the plan typically are those who can substantively affect the direction and success of the institution through their control over some aspect of the organization. In nonprofits, this is usually the executive team as variously defined (e.g., the operating committee). Nevertheless, in institutions that tend to have egalitarian worldviews where many have direct service roles, it most likely would be unpalatable to pay some for the success of the college or university if others weren't recognized and benefited in some way as well. As noted by Vaillancourt, such a one-sided arrangement would be anathema to culture and a morale-killer. Colleges and universities would have to convey some form of recognition for institutional success whether in the form of enhanced annual increase budgets or cash or noncash awards.

No standards exist in nonprofits for the target amount of cash that can be awarded at the end of a plan cycle, and we do not think the standards in corporations provide appropriate models. Colleges and universities have to be particularly sensitive to their nonprofit missions when considering bonuses. Still, a long-term bonus needs to be of significant value to offset erosion of its perceived value due to the time delay of its potential receipt. We have provided hypothetical values in Exhibit 1. As shown, the amounts vary by salary and organizational level.

EXHIBIT 1: HYPOTHETICAL PAYOUT GRID FOR A FOUR-YEAR, LONG-TERM PERFORMANCE PLAN

Base
Salary
Percent Payout* Target
Value
Performance Unit ($1)
President $750,000 50% $375,000 375,000
First-level officers ** 40%
Second-level officers ** 30%
President $500,000 42.5% $212,500 212,500
First-level officers ** 35%
Second-level officers ** 25%
President $400,000 35% $140,000 140,000
First-level officers ** 25%
Second-level officers ** 20%
President $250,000 27.5% $68,750 68,750
First-level officers ** 20%
Second-level officers ** 15%
President $150,000 20% $30,000 30,000
First-level officers ** 15%
Second-level officers ** 10%

*Payouts would be based on actual salaries.
**Calculations for this line are the same as for presidents using dollar values pertinent to that level.
Source: Sibson Consulting

Performance units are awarded based on the targeted monetary amounts. For example, if the value of a unit were initially $1, then a person with a $30,000 target would be granted 30,000 units. An actual (non-marketable) certificate can be printed to designate the units offered and to remind holders of the mission of the enterprise (i.e., what the units are for).

The value of the unit can change over time based on the institution's performance. We will keep the illustration straightforward and use one long-term measure, student retention, but other measures can be added and weighted. For example, an institution may want to add four-year graduation rates as a measure and give it a weight on par with retention and determine payouts by computing a simple weighted average of the measures, although there are several other ways to combine multiple measures.

With retention as the measure of choice, there are two types of performance standards to apply. One standard can be internally generated based on institutional objectives and set a percentage increase target accordingly. A second standard is comparative. An institution may identify similar institutions with similar experiences with retention, and set a relative goal (e.g., to increase 2 percentage points more than the comparison institutions).

Time Frames and Payouts

Payouts are based on actual achievements at the end of the plan period against goals. For example, the payouts may be assigned according to the schedule illustrated in Exhibit 2.

EXHIBIT 2: DOLLAR VALUE PER UNIT

Increase in Retention Rates Unit Value Unit Price
≥ 6% 1.75X $1.75
≥ 5% 1.50X $1.50
≥ 4% 1.25X $1.25
≥ 3% 1.00X $1.00
≥ 2% 0.75X $0.75
< 2% 0.00X $0.00

 
Notice that outcomes below a certain level are not fundable: No bonuses are paid. All results also might be predicated on the institution maintaining its academic standards and the quality of the students it produces. That is, conditions might be established which, if satisfied, allow payments to be made, and vice versa. Suppose, after a four-year period, the institution had increased retention rates by 3.68 percent. A president with 140,000 units would earn a pro-rated amount of $1.17 per unit, or $163,800. Over a four-year period, this amounts to $40,950 per year.

Because incentive plans can invite unintended consequences, the idea behind inserting conditions (called "triggers" in comp-speak) is to highlight that the institution wants to achieve its long-term goals, but not at the expense of giving up something else of value. Long-term plans are one way to create institutional focus, arrange priorities, and concentrate efforts. The designs and values associated with this sample plan can be flexibly adapted to any institution.

Author's note: We would like to thank Mary Opperman (Cornell University vice president and chief human resources officer), David Trainor, and Allison Vaillancourt for their comments on an earlier draft of this paper. All opinions are ours and we are solely responsible for all statements made.

Michael O'Malley is a senior vice president and higher education compensation practice leader with Sibson Consulting. He has more than 30 years of experience in compensation, performance management, organizational design and effectiveness, and selection and leadership development. E-mail: momalley@sibson.com.

Jason Adwin is a senior vice president with Sibson Consulting. He has nearly 20 years of experience working with organizations on their human capital strategies with special expertise in compensation and performance management. E-mail: jadwin@sibson.com.