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Connections Between CEO Pay and the Size and Complexity of the Organization

Posted on October 21, 2013 by Gallagher Integrated

Last week Modern Healthcare published, “Hospitals with Expensive Tech, High Patient Satisfaction Have Highest-Paid CEOs.” In this article, Ashok Selvam, writes that pay for non-profit CEOs has little to do with their quality scores or performance. Selvam also writes, “high-level executives generally make more at hospitals with expensive technology and high marks in patient satisfaction, according to a new study published in JAMA Internal Medicine.”

INTEGRATED Healthcare Strategies conducted research earlier this year and came to a similar conclusion as the JAMA study, finding no significant connection between CEO pay and a hospital's financial performance or its performance on process quality, mortality or readmission rates. However, we found that there is a significant connection between CEO pay and the size and complexity of the organization. Larger and more complex organizations like academic health centers and integrated health systems pay more than smaller, less complex organizations. As a result, net total operating revenue is a reliable predictor of pay for executives.

One commenter in the article takes issue with the suggested lack of connection between pay and quality, explaining that the study uses only a limited set of metrics and that perhaps hospitals measure and reward different metrics. While there are certainly many variables that can influence pay, our research shows that the majority of CEOs do have incentives tied to the very metrics the JAMA study cites. In fact, 80% of CEOs have annual incentives. The most common metrics used in those incentive plans are financial performance (usually operating margin or income), process quality (typically the process metrics in the CMS Value-Based Purchasing program), and patient experience (typically HCAHPs scores), followed closely in prevalence by readmissions and mortality.

So if the majority of CEOs have performance-based incentives, and most of the incentive plans measure performance in the aforementioned areas, why is there little connection between CEO pay and performance in those areas? There are two key considerations. The first is that while most CEOs have annual incentives, those incentives make up only a small portion of total compensation. According to INTEGRATED’s 2013 National Healthcare Leadership Compensation Survey, the average annual incentive award for CEOs was about 35% of base salary. When you factor in benefits, incentive pay makes up, on average, less than a quarter of the total compensation typically provided to a CEO of a not-for-profit hospital or health system. So while pay for CEOs is variable, it is still largely driven by base salary.

The other consideration is that the level of performance required to earn an incentive varies greatly among organizations. Pay—including incentive pay—for CEOs at non-profit hospitals is typically set by the compensation committee of the board. When measuring and awarding performance, many of these committees look only at how performance compared to the prior year; few look at how performance compared to other hospitals like them. In other words, CEO pay is typically linked to financial performance, process quality, readmissions, etc., but it’s linked to progress compared to prior results, not relative performance compared to the industry. A CEO at a lower performance hospital who makes incremental gains in performance may receive the same award as a CEO at a high performing organization who maintains that high level of performance.

While there is no simple, one-size-fits-all solution for designing incentives for CEOs that strengthen the connection between pay and performance, it has to start with the boards and compensation committees that oversee executive pay, including incentives. Getting good information about the organization’s performance in comparison to peer organizations is a good first step.

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