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.

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