Attracting and keeping quality leadership crucial to success
Executive compensation realities in healthcare are best understood as a product of the organizational structure of a healthcare provider, not as a foundational goal. But because of the importance of quality executive leadership both in determining and carrying out a provider’s goals, the significance of executive compensation lies in its ability to attract and retain talent.
Healthcare has a large segment of highly profitable for-profit enterprises, often backed by private equity, but also includes, nonprofit enterprises, with these entities generally well-funded as well. Nonetheless, there are sometimes a wide disparity of financial assets available across those two different segment types, and that makes a difference in executive compensation, even though the skill set for executive positions in healthcare in both segments are comparable.
What that means is that nonprofit systems are going to be competing against for-profit organizations for the same talent, likely with less to spend. Grant Thornton Human Capital Services Senior Manager Carver Draughn said this has always been a challenge for nonprofit companies in that they have to compete for executive talent in the same pool of candidates but with different revenue stream from which to draw upon.
At the same time, healthcare organizations that always operate on low margins compared to other industries, are facing more cost pressures than usual, which inhibits their ability to offer competitive compensation packages.
“Right now, even well-run, well-respected, large health systems are under financial strain just due to the economic conditions of the hangover from COVID-19,” said Grant Thornton National Managing Principal of Healthcare David Tyler. This places day-to-day operational pressure on executives, which must figure into their compensation.
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For-profit and nonprofit compensation strategies
With pressure on providing attractive executive compensation in healthcare, as with many other industries, healthcare providers must focus on elements of a total rewards package. A company can start with the base salary, annual incentives, plus core qualified benefits—qualified medical and retirement plans, for instance. These types of practices are common in both for-profit and not-for-profit organizations. However, it is also common for health care executives to receive two, and sometimes more, non-qualified (i.e., executive-specific) benefits such as deferred compensation, supplemental insurance and professional development opportunities. The non-qualified benefits are one way nonprofits can compete with for-profits, which typically provide lucrative long-term incentives in the form of stock or other equity.
Long-term incentives, especially equity incentives, can be effective at public companies and for-profits in general, but nonprofits are more limited in what they can do. Nonprofits are increasingly providing long-term incentives, but it is still not a majority practice, with nonprofits offering only a fraction of the long-term incentives seen among for-profits.
Although compensation may be lower in nonprofits, they still compete for similar talent, but will rely upon a combination of the provider’s mission, more aggressive non-qualified benefits, and a modest long-term incentive plan to win the competition for talent. Note however, that nonprofit compensation must be reasonable and not excessive. An analysis of competitors can help set appropriate parameters, Draughn said.
An organization would typically use more short-term incentives to address more immediate and critical needs.
One way to think about a compensation perspective is to define when short-term versus long-term compensation provides the best incentive, Draughn said. “An organization would typically use more short-term incentives to address more immediate and critical needs.” This was especially true during the COVID-19 pandemic when turnover was high. Today, Draughn said, organizations can evaluate the transformations within their healthcare organizations and the overall industry environment, and use incentives to execute strategy for longer-term sustainable needs.
In the nonprofit sector, Tyler said, you tend to have longer tenured executives than you would typically see in a for-profit sector, partly because the pressure for profits doesn’t exist and short-term performance isn’t as much a decision-making factor. “If you make a mistake, it doesn't show up in your earnings report every quarter. This enables some organizations to play the long game,” Tyler said. Nonprofit governing boards, as a result, have a little bit more patience and can look past present day’s circumstances. That naturally lends itself to executives being there for longer periods of time and that can be an incentive for executives seeking more security rather than more pay.
Compensation and value-based care
In a general sense, executive compensation must be appropriate to how an organization is structured since strategy and business models should always be closely aligned to this structure. Healthcare structuring itself is in a bit of a transition as value-based care models become more popular.
In these systems, payments for received care are determined based on quality of care provided. This is determined by measuring outcomes of a healthcare organization against data bases such as the overall health and demographic makeup of the population served by the provider. Providers then track and report on such data points such as patient engagement, occurrence of complications, and readmissions.
Essentially, value-based care is a financing model, but by measuring non-financial metrics to provide a basis for charging patients for healthcare services, those metrics also can be used to determine terms of executive compensation packages, Tyler said. In the value-based healthcare model, it’s important to improve quality scores, and that has already been used as a metric for evaluating chief medical officers and the chief nursing officers and other executive positions that must have a clinical background. Health quality scores could be used as a metric to measure performance for CEOs, CFOs and other non-clinician compensation as well. It’s a matter of assessing quality and cost and using metrics for people who have typically not previously been measured against clinical care quality and cost-of-service delivery.
A factor in M&A due diligence
Healthcare mergers and acquisitions have been on the rise for more than a year, but it’s often not appreciated how much executive compensation plays a role in negotiations. Draughn said when healthcare organizations are performing a due diligence examination, executive compensation is one of the biggest red flags in a potential deal.
“Executive compensation typically is the most complex area that we have to look at during and M&A due diligence,” Draughn said, “and it should include a detailed analysis of the current compensation plans, the severance packages, and the other employment agreements. From a buy-side perspective, there's an immediate focus on what the organizations involved can do from a retention perspective if they want to keep key executives because talent can really impact the future success of a transaction and integration.”
From a sell-side perspective, Draughn said, organizations can use severance agreements as a tool to motivate executives to set the organization up for a successful deal, as a buyer would want to understand what those potential costs are, and which party is liable for the cost before the deal is finalized.
I've seen deals blow up because certain executives or Board members don't get the settlement that they're looking for, which is a clear violation of their fiduciary obligations.
During due diligence, the acquiring organization will decide what members of the executive team to retain. The severance amounts for executives who will not be retained can be built into the deal. The integration budget needs to address the additional costs of payments to executives who will be leaving the organization.
The inverse of that is also an issue. There needs to be retention dollars to retain executives who might be inclined to use a merger to seek new employment. “I've seen deals blow up because certain executives or board members don't get the settlement that they're looking for, which is a clear violation of their fiduciary obligations,” Tyler said. “That happens on a regular basis.” Draughn said a prevalent trend with retention bonuses is designing them to occur at certain dates, tailored to the timeline of the deal and the integration period, to help ensure success.
While executive compensation policies should never be a driving factor in forming healthcare operational strategy, it is important that that strategy shapes and provides incentives to attract the right leaders to guide it. A healthcare organization board can jeopardize a sound organizational strategy when their leaders aren’t able or willing to implement it.
Healthcare governing boards considering what should be in a compensation package to fill an executive opening should ask a few key questions when forming a strategy:
- Is this a short-term or long-term need?
- Have we studied competitors’ compensation to make sure ours doesn’t fall short?
- What are the unique strengths in our mission, our location and/or our culture that distinguish us?
- In an M&A situation, how does executive compensation inform retention decisions?
Often, questions such as these involve factors that can lay beyond the expertise of a healthcare governing board, and third-party advisors can be a help in filling in those knowledge gaps and help ensure a successful process.
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