Executive Compensation

Connecting Executive Pay to Performance

November 10, 2016 9:49 am

Hospital executives presumably affect hospital performance, so why not connect their pay to their performance?

Executive compensation has been in the headlines since the financial crisis of 2008. The watchdogs of Main Street publicly shamed the sky-high compensation for executives who ran their companies into the ground and laid off thousands of workers. Healthcare was no exception—note the scrutiny of the compensation of United Healthcare’s CEO (Bowman, D., “UnitedHealth Group’s Stephen Hemsley – CEO Compensation,” FierceHealthcare, May 14, 2009).

Therefore, it seems that the boards of healthcare organizations should focus on connecting executive compensation to performance, and that connection is possible today.

Increasing Scrutiny

Healthcare executives’ compensation in the United States parallels the compensation of executives in other U.S. industries. However, there is mounting criticism about the compensation packages of hospital CEOs (Evans, M. “Despite increased scrutiny, executive pay at not-for-profit hospitals still on the rise,” Modern Healthcare, Aug. 10, 2013). Legislators, including former Sen. Chuck Grassley of Iowa, condemned not-for-profit healthcare organizations for not demonstrating community benefit in lieu of not paying federal and other taxes. Fast forward to a couple of years ago, when the IRS promulgated a host of rules related to Form 990 and tax-exempt status that have once again put the spotlight on executive compensation (Rukavina, M., “Considering Collection Actions Under New IRS Regulations,” Revenue Cycle Strategist, HFMA, April 2015).

Beyond negative publicity, the IRS routinely audits the compensation of tax-exempt organizations. If the audit concludes that the executive compensation is more than allowed, “intermediate sanctions” may be imposed. These sanctions are not as devastating as the healthcare organization losing its nonprofit status, but they are not to be taken lightly.

Involving the Board

Given the heightened scrutiny of stakeholders ranging from compensation watchdog groups to the IRS, oversight of reasonable executive compensation must be standard board practice. One common practice for boards is to compare executive compensation among similar healthcare organizations. There is no absolute prescription to guide boards in determining whether executive compensation has fallen out of the realm of what the IRS may regard as reasonable, but comparability data help.

Linking Pay to Performance

However, this outward-looking view of executive compensation does not address the key question: Does executive compensation drive or block organizational performance? The empirical challenge this question poses is that causality between executive compensation and organizational performance is difficult to establish.

A Mercer and Truven Health Analytics study found a significant positive association between CEO compensation and financial, quality, and other performance metrics for those hospitals that ranked in the top 10 percent of all hospitals, but the study did not establish whether the higher compensation drove the higher performance or vice versa (Koepke, D., Foster, D., Bilak, D., et al., “CEO Compensation at Nonprofit Hospitals: Associations with Performance Measures,” Mercer and Truven Health Analytics, January 2016). In contrast, the study also found that CEO compensation shows a significant negative association with inpatient complications of care and adjusted expense per inpatient discharge.

The fact that the industry is beginning to rely on data to show the statistical impact of CEO performance on organizational outcomes is significant and long awaited, especially among physicians and providers who have been increasingly paid based on performance that is also measured in statistical terms and relying on empirical data. Pay for performance, if embraced by a healthcare organization, should apply from the top to the bottom in healthcare organizations. Because healthcare organizations and physicians are increasingly reimbursed based on performance, it makes sense that boards should also increasingly compensate executives that way, rather than basing compensation on what similarly situated CEOs earn or on organizational characteristics such as number of beds.

A truly innovative healthcare organization could take this analysis a step further and start looking at compensation as an investment instead of just an expense. We know that performance is now rewarded by payers, so if a correlation between performance and executive pay can be established, an ROI can presumably be calculated.

And here’s another idea: How about adding intangibles into the equation? A hospital’s reputation and community standing, for example, may be difficult to connect to dollars earned, but in the long run, such intangibles pay off, so why not reward executives for cultivating them? The ROI and the intangibles could be rolled into one equation that determines the appropriate level of an executive’s pay.

Assessing the Top-Down Impact

Another question about the connection between executive compensation and performance is the effect that it has on others in the organization, especially those whose compensation largely remains constant regardless of the performance of the healthcare organization. Does higher executive compensation and perceived disparities augment or impede the performance of the hundreds, thousands, and tens of thousands of workers in healthcare organizations?

At a meeting I attended recently, a middle manager said, “I don’t get paid enough to make those decisions…those decisions are for those who make the big bucks.” This comment suggests a certain degree of disengagement as a result of perceived disparities related to the pay gap. It would be interesting to assess these sentiments further down the organizational hierarchy.

A hospital’s human resources department might have a handle on these sentiments if it asks employees the right questions. For example, an innovative human resources department could collect quantitative and qualitative data on perceptions regarding compensation and the impact of compensation on performance.

Using New Data to Make Connections

Healthcare financial professionals and boards of directors should examine the effects of executive compensation in their own organizations. Given the availability of clinical, population health, and financial data, it is now possible to conduct an analysis to determine if executive compensation plans are driving organizational performance as expected or blocking organizational performance. Executive compensation could be adjusted accordingly.

William Marty Martin 
is associate professor and director of Health & Human Resources Programs and Coleman Entrepreneurship Faculty Fellow at DePaul University, Chicago.


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