What is Flexible Compensation?

Attracting and retaining top talent is more challenging than ever in today’s competitive job market. While salary and benefits have always played a significant role in an employee's decision to join or stay with a company, the modern workforce demands more. 

Enter flexible compensation—a game-changer for companies looking to offer more personalized and attractive compensation packages.

Our co-founder and CEO, Jafar, recently had the opportunity to speak at the World at Work Total Rewards Global Forum in Canada, where he presented the concept of flexible compensation and how it can empower employees to take control of their total rewards and improve employee retention. 

This blog post will break down what was presented, explore what flexible compensation is, its benefits and drawbacks, and how it works. Our goal is to provide HR and Total Rewards professionals with the insights needed to implement this innovative approach.

What is Flexible Compensation? 

Flexible compensation (also known as flex pay, flex comp, or agile compensation) is a compensation approach that gives employees the ability to choose how their total compensation is allocated across different elements of their pay, but more specifically their base salary and equity compensation. In some cases, it can also include personalizing their benefits, work arrangements, and even their variable compensation (e.g. bonus and commissions). 

For this post, we’ll focus on employees selecting their mix between their base salary and equity (e.g. stock options or RSUs). 

The idea of presenting candidates with multiple compensation options (e.g. one with a higher base salary / lower equity or lower base salary / higher equity) has been around for quite some time. In fact, it’s been very popular with early stage technology startups. It was historically done to entice early employees with the opportunity to take more ownership of a potential rocketship, while allowing the company to conserve cash. 

In today’s market, the idea of flexible compensation continues to evolve with companies like Shopify introducing their Flex Comp program in 2022, allowing employees to choose their mix of cash and equity to meet their financial needs and comfort levels with risk. At Netflix, employees choose how much of their compensation they want in salary versus stock options each year. Employees can choose all cash, all options, or whatever combination suits them best.

A Major Driver for Flexible Compensation

Historically, when an employee first joins a company, they are presented with an offer that includes their fixed salary and equity mix. From an equity perspective, it usually includes a meaningful equity grant that vests over a predetermined period (e.g. vesting over 4-years).

One of the issues with this approach, especially for publicly traded companies, is the timing of when you join a company could “determine your fate” and your total compensation.

What do we mean by this exactly?

Imagine joining a company when its share price is at $150 a share. It’s an exciting time and the company is booming! However, fast forward a few months and a looming recession emerges which tanks the stock down to $25 a share. 

What that means to you as an employee is that the total compensation you expected just tanked along with the stock market. This is no fault of your own and it results in you feeling stuck. 

On the flip side, if you were to join while the stock is down to $25 a share, you may be able to ride that share price up over time and substantially increase your total compensation.

The historical assumption has been that a company’s share price always goes up, but we know that isn’t true. 

This is why having a flexible compensation program that redefines vesting schedules and provides agency to employees can be very powerful.

How does Flexible Compensation work?

Provide Choice Windows

It starts at the initial offer where a candidate has the ability to select their compensation mix before their start date. In addition, employees are given a specific window once (or multiple times) per year to adjust their compensation mix. During these periods, they can opt for a higher base salary with lower equity or a lower salary with more equity. This periodic adjustment allows employees to respond to changing financial needs and goals.

Update Vesting Schedules

In line with having choice windows, companies need to rethink their approach to vesting schedules. The standard “4-year vest with a 1-year cliff” does not align well with a flexible compensation approach. For example, Shopify has removed one-year cliffs on equity, ensuring that vesting begins right away, including for new employees. 

Set Up Admin Tools and Resources

Customization is facilitated by tools and resources that help employees understand the potential long-term benefits and risks associated with their choices. For instance, Shopify’s system uses an intuitive slider mechanism, allowing employees to visualize the impact of their decisions in real-time. These tools ensure that employees make informed choices that align with their financial objectives.

Communicate and Educate

Clear communication about vesting schedules, potential financial outcomes, and tax implications is crucial. Employees need to understand the full picture to make decisions that suit their personal financial goals. Transparent communication builds trust and ensures that employees feel confident in their choices.

To make this possible, companies often provide online portals where employees can log in and adjust their compensation preferences. These portals include educational resources, FAQs, and financial calculators to help employees understand the potential outcomes of their choices. By providing these tools, companies ensure that employees are not making decisions in a vacuum but are fully informed about the implications of their choices.

What are the benefits of flexible compensation? 

• Attract top talent: Offering flexible compensation can be a powerful tool to attract high-quality candidates. Talented professionals seek employers who offer more than just a paycheck—they want personalized compensation that reflects their individual needs and goals. By providing this flexibility, your company can stand out and draw in top talent.
• Improve employee retention: Flexible compensation can enhance employee retention by increasing job satisfaction. When employees feel their compensation aligns with their personal financial goals, they are more likely to stay with the company. This alignment reduces turnover rates and fosters a more loyal and committed workforce.
• Enhance motivation and performance: When employees have a say in their compensation, they feel more valued and motivated. This empowerment can lead to higher productivity and performance levels as employees strive to meet their financial goals. Offering flexible compensation shows that your company values its employees' input, which can positively impact morale and motivation.

What are the cons of flexible compensation? 

• Employees “don’t know” what’s best for them: One significant drawback is that employees may lack the financial literacy to make informed decisions about their compensation. Without proper guidance, they might choose options that are not in their best long-term interest. This issue underscores the importance of providing comprehensive education and resources.
• Higher administrative cost: Implementing a flexible compensation system can be costly and complex. The administrative burden of managing individualized compensation packages and ensuring compliance with legal and financial regulations can be substantial. Companies need to weigh these costs against the benefits of offering flexibility.
• It’s more challenging for private companies: Private companies face additional challenges with flexible compensation due to the complexities of valuing equity and managing liquidity. Unlike public companies, private firms lack a readily available market for equity, making it harder to offer and manage equity-based compensation.‍
• It can be difficult to reverse: Once a flexible compensation system is in place, it can be challenging to reverse. Especially when it comes to private companies, a compensation mix decision may be difficult to undo if an employee’s circumstances change

Key considerations for Flexible Compensation

Valuation

This is much simpler for public companies where the stock market sets the price and employees have visibility to their share price at any point in time. However, for private companies, it is essential to conduct a new valuation at least once per year (or at any major event like a new round of funding). In addition, private companies need to commit to being more transparent with their share price and how valuations are conducted so that employees are aware of the value of their equity compensation. 

Vesting Schedules

As mentioned earlier, your equity vesting schedules need to be reviewed to align with your flexible compensation program. Maintaining a longer vesting schedule makes it more difficult to unwind compensation mix decisions and reduce flexibility for employees. On the flip side, extended vesting schedules and vesting cliffs protect the company’s equity pool and act as a longer term incentive for employees. 

Liquidity

If you are a public company, your employees have access to greater liquidity as they are able to sell / trade their shares. When it comes to private companies, equity compensation is typically illiquid and it can only be sold during major events (e.g. strategic acquisition or secondary sale). Providing information about potential exit strategies and liquidity events can help employees better understand the value of their equity.

Administration

Administering a flexible compensation system requires robust systems and processes. Companies must ensure that they have the necessary infrastructure to manage individualized compensation packages and comply with legal and financial regulations.

Education (For Employees and Managers)

Comprehensive education is critical for the success of a flexible compensation system. Employees need access to resources and tools to make informed decisions, while managers require training to effectively communicate and support their teams. 

Taxes

Base salary and equity may have different tax implications for employees. While employees should always seek professional financial and accounting advice, it's important for organizations to share information on the potential tax of different compensation choices to help employees make informed decisions.

Pay Equity in Flexible Compensation

When employees all have their own personalized mix of base and equity compensation, how are you able to ensure that you are maintaining equitable pay between your team members? 

Let’s consider the cases of two employees, Nadia and Daniel, who both start with a total compensation of $200,000. Nadia opts for a lower base salary in exchange for higher equity compensation, while Daniel chooses a higher base salary and lower equity. 

Initially, they appear equal in terms of total compensation, but the scenario shifts dramatically if the company’s stock price doubles. In this case, Nadia's total compensation could increase by nearly $50,000 more than Daniel's, raising questions about pay equity when their pay diverges. 

Conversely, if the stock price falls, Nadia faces greater risk and may end up earning less than Daniel, highlighting the need to consider both the upside and downside of equity-based compensation. 

So, is it considered equitable that Nadia is making more than Daniel when the share price doubles? Or is it considered equitable that Daniel is making more than Nadia when the share price falls by half?

There could be many arguments around pay equity in this situation. Especially when you think about individual employee circumstances and their personal financial situations impacting the compensation mix that they are able to select. 

Tracking Total Compensation Offered

As an organization, one metric to consider tracking is “Total Compensation Offered”. In the example of Nadia and Daniel, it would be the initial $200,000 that they were each offered rather than where they ended up based on the stock price in the future. This ensures that you are maintaining an apples to apples comparison for what you offered to each employee. This becomes another compensation metric that needs to be continuously tracked in your HRIS over time. 

By defining a robust pay equity philosophy and creating “Total Compensation Offered” pay bands, companies can effectively navigate the complexities of flexible compensation and ensure fairness for all employees.

Effectively Communicating Projected Equity and Outcomes to Employees

One of the critical components to a strong flexible compensation program is ensuring clear and consistent communication when it comes to total compensation - this is especially important when it comes to providing visibility and education on equity based compensation like stock options and RSUs. 

With compensation management software, you can help employees understand the value of their stock options with a total rewards portal that shows each employee visualizations of their total rewards including base pay, stock options, and benefits. Barley makes it easy for employees to see the value of their stock options and explore various outcome scenarios using our equity projection tools.

Improve Employee Retention with Personalization

Flexible compensation provides a more personalized approach to each employee’s pay. It allows employees to align their personal financial goals and risk tolerance with how they get paid. This becomes a powerful tool to boost both employee retention and engagement. 

This personalized approach is becoming more and more appealing to the modern workforce as we see it applied to benefits. According to MetLife’s 2024 U.S. Employee Benefit Trends Study, 79% of employees want benefits tailored to life stages, as well as their positions and personal circumstances. By offering this flexibility, employees will have a stronger perception that they feel cared for by their employer which is a success indicator reported to have a positive affect on job satisfaction, engagement, loyalty, and productivity. 

In order to effectively implement personalization in compensation, your company needs to think about how it aligns with your company goals, implications for you as a public or private company, and the costs and benefits of administering.