Achieving Harmony on Pay, Retention When Companies Merge

Strategically merging companies is critical to driving new growth and unlocking value for both organizations involved in a mergers and acquisitions (M&A) transaction. But beyond the operational and market awareness challenges, management and human resources teams face pressure when the merging organizations have major differences in culture and compensation philosophy.

When integrating companies, retention and engagement are crucial; in particular, compensation plays a huge role in accomplishing those objectives. Since mergers often include companies in the same industry with similar talent dynamics, the likelihood of major discrepancies in pay philosophy is probably minimal.

But in today’s executive compensation environment, and nearly a decade after the advent of say on pay, companies are becoming more willing to push the boundaries on pay philosophy to attract and retain talent. One popular example is Netflix, where executives can choose how they want their compensation delivered between salary and stock options (I hope no one has buyer’s remorse!).

So, what happens when two merging companies have completely different compensation philosophies? Imagine that a company with a pay mix philosophy that is heavier on cash (versus equity) merges with a company that is lower on cash but delivers more equity: The combined company probably can’t afford to increase cash for one group of employees and increase equity for another to create consistency. Additionally, companies can also have other philosophical differences on issues like equity grant practices (e.g., time-based restricted stock versus options versus performance-based restricted stock) or cash incentive designs (e.g., formulaic versus discretionary versus no program).

What philosophy will win the day, and how do you harmonize the programs while integrating the businesses? Boards and their organizations can take several key steps:

1. Determine the rationale. Boards should start with the strategic rationale behind the merger—that is, “What are the business objectives we believe we can achieve?”—and then ask, “What is the talent strategy necessary to achieve the business strategy?” A compensation philosophy is sub-optimal if it does not support the organization’s underlying business, talent, and culture, which makes articulating the talent strategy essential.

Let’s go back to the previous example of companies with different pay mix philosophies: If the merged company’s talent strategy is to drive a heightened performance culture through equity ownership, then the low-on-cash, high-on-equity philosophy may be the right path forward. This doesn’t necessarily mean that the organization needs to immediately replace cash with equity for individuals that were previously high on cash and low on equity. Rather, the company should develop a strategy on how to manage this issue over time.

2. Assess the pay philosophies. After defining the talent strategy, management teams should consider conducting an assessment on key elements of the pay philosophy to recognize where similarities and differences exist on issues such as the prominence of pay, market positioning, and mix of incentives. Developing this framework will help determine the scope of the issues and develop a timeline with priorities.

Throughout this process, it’s important to recognize that harmonizing pay programs will not happen overnight and may take a couple of years. As with any other change to an organization, articulating and communicating the desired compensation philosophy going forward can help management teams transition to the desired end state.

3. Focus on retention and engagement. Once the compensation philosophy is articulated and has a roadmap, the company can turn to the issue at hand—retention and engagement through the transition. Retention actions are not always necessary but can be used on a targeted basis.

For those individuals for whom specific actions may be appropriate, there is a spectrum of approaches to consider. The decision often depends on the criticality of the role, the desired retention and engagement period (i.e., short-term versus long-term), and if there are any specific performance milestones to achieve. A few approaches include increasing severance protections for a period of time before sunsetting to original protections, delivering cash stay bonuses for near-term transitions, or awarding meaningful equity grants for those critical to the long-term succession plans of the organization.

The best outcome when going through a merger is to reduce (and, if possible, eliminate) any distraction that takes focus away from the business needs. A clear compensation philosophy and framework based on future business objectives can allow a company to move forward rather than being stuck starting with the programs of the past.

Partnering the pay philosophy with a thoughtful approach to retention allows companies to spend more time thinking about the next strategic business decision to drive shareholder value rather than worrying about the loss of talent and delayed integration efforts.

Semler Brossy is a NACD partner, providing directors with critical and timely information, and perspectives. Semler Brossy is a financial supporter of the NACD.

Michael Gorski is a senior consultant with Semler Brossy Consulting Group working out of the Los Angeles office.