Crypto Pay Guide - Compensation Governance
0xEB2c
March 22nd, 2022

The Crypto Pay Guide is a series of articles that will be authored and released by C3 over the coming weeks. Each article will cover a separate compensation topic, focusing primarily on full-time employees in web3.

What has the Crypto Pay Guide covered so far?

  1. Objectives & Compensation Risk
  2. Compensation Model
  3. Compensation Process

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In our second article, “Compensation Model”, we summarized the prevalent model used among web3 organizations and we covered the unique market factors that make compensation challenging. In our third article, “Compensation Process”, we summarized the retentive power of having a well-designed compensation governance process. In this article, we combine insights and outline how a compensation model can be evaluated through a robust compensation governance process. We cover the importance of utilizing different pay components to achieve talent objectives and we outline how compensation vehicles can be reviewed within a governance framework.

Compensation Model by Employee Level

For traditional organizations, the use of a base salary, a bonus, and equity compensation is common. Bonus and equity is defined as “variable pay” because its value is subject to performance (e.g., predetermined bonus goals, token price).

The allocation of base salary, bonus, and equity compensation is defined as “pay mix”. For executives of publicly traded corporations, about 10-30% of their total pay is in base salary, 20-40% is in cash bonus, and 40-60% is in equity compensation. An organization should regularly evaluate its pay mix by employee level to ensure it is meeting its talent objectives. There is no “one size fits all” model, although organizations that use all three pay types are better equipped to accomplish their compensation goals because they will have more levers to pull.

Below is a graphic that outlines a generalized approach to allocating variable pay by employee level:

Employee level is shown on the left-hand side starting from the top of the organization (i.e., leaders) and ending at part-time employees. Each subsequent category differentiates as you move down employee level. Let us dive into the various considerations.

The graphic above is a generalized model that is common among traditional companies. Many web3 organizations do not currently adhere to this generalized model because:

  • They are highly decentralized and prefer one compensation framework for every contributor. A DAO may choose to not differentiate employee pay by level to prevent indirectly establishing leadership or organizational hierarchy. This fits within the ethos of decentralized compensation although is largely still an experiment. C3 is monitoring how a lack of compensation differentiation affects a DAO’s ability to scale and attract talent.
  • They do not differentiate by employee level because they do not have the data, tools, expertise, or capabilities to do so.
  • They do not use performance-based pay vehicles, like bonus plans or performance tokens. This limits the effectiveness of compensation as a retentive and motivational tool, especially for leadership roles.

The lack of differentiation and performance-based pay may be partly due to an unstructured governance process that does not regularly evaluate such provisions.

Compensation Governance Design

A robust compensation governance process needs to be established to ensure accountability, regularity, independence, and fairness. A well-designed process provides flexibility to evaluate key compensation frameworks and performance-based incentives. It is recommended that protocol leaders do not review and establish pay levels for themselves. This process should instead be managed by the community.

There are three prevalent compensation governance mechanisms in use today:

  1. Direct vote: a proposal is submitted that outlines proposed pay levels and the community votes on implementation. This process has the strongest link of accountability between the community and the employee, although criticisms may arise, such as: Who is submitting the proposal? How were the proposed pay levels established? Are the market competitive? Were protocol leaders involved or was this an independent process? Did compensation experts opine on the levels and design?

    A direct vote may also limit the scalability of a DAO and introduce voter fatigue as every decision must be approved by the community.

  2. Community-Elected Council/Committee: The use of a community-elected council of delegates is increasing. This group is similar to a Board. Delegates are elected on a periodic basis and the council may have compensation oversight, with budgets approved by the community on a periodic basis. It is important to note that decisions can be made without a community vote, although delegates should act on behalf of the community.

  3. Community-Elected Council + Direct Vote: A “belt and suspenders” approach to compensation governance. The community-elected council may independently evaluate pay levels and incentive design, but the final decision cannot be made without a community vote.

All three governance mechanisms are appropriate, although C3 believes establishing a community-elected council provides the greatest flexibility. It is recommended that the council defines its scope regularly via a community vote and conducts an election process at least once per year. An independent council is an efficient mechanism because it prevents voter fatigue and creates flexibility to address unique talent factors, especially for decisions made regarding lower-level employees.

The community-elected council and direct vote (design #3) is a great approach to address compensation for protocol leaders. This way, the protocol maintains flexibility yet ensures accountability. A community-elected council will have the ability to tap into an approved budget to engage with outside experts. The final proposal can also be submitted by the council, which maintains independence. A direct vote promotes direct oversight and accountability. If failed, the council can re-work its proposal accordingly.

The use of a council without a direct vote (design #2) can also be suitable for evaluating compensation for protocol leaders as long as the council is transparent with its decision.

A similar process is done for executive pay decisions at publicly traded corporations. The Board reviews executive pay programs with outside consultants and then recommends changes. Executive pay levels are not subject to shareholder vote, but corporations do have an indirect method of accountability via an annual “Say-on-Pay” vote where shareholders can signal approval of the Board’s overall compensation decisions. The “belt and suspenders” governance mechanism (i.e., council + vote) results in a stronger link because community members have a direct influence over the pay outcomes for protocol leaders.

If a council does not exist, a direct vote (design #1) is also appropriate for protocol leaders, but it is important that the proposal is independently evaluated by outside experts to ensure it is market competitive and fair. The outside experts can be engaged by the community via a separate proposal and can also lead the review process.

Combining Compensation Model & Process

In this section, C3 outlines how a protocol can regularly evaluate its compensation model by employee level through its governance process.

For Protocol Leaders

C3 recommends a “top-down” approach. The organization would first design the compensation program for protocol leaders and then extrapolate features to other employees. Below are generalized steps a web3 organization can take to properly evaluate its compensation model for leaders:

  1. Benchmarking: The community or council can engage outside experts, like C3, to assist in benchmarking compensation levels using competitive market data. Base salaries, bonus levels, and token ownership percentages can be evaluated. Market data should include compensation information for similar jobs at traditional technology companies (both private and publicly traded), as well as crypto organizations, to the extent available.

    Generally, base salaries and target bonuses should be positioned near the market median. Positioning above or below the median is appropriate with sufficient rationale. For example, a leader who is positioned at the 25th percentile may be a new hire who has limited experience in the role. Or, a leader who is positioned at the 75th percentile may be highly tenured or may be a stellar performer. The organization’s talent strategy may also warrant above-median positioning. For example, a protocol may need to attract leadership from a traditional technology company and thus require 75th percentile pay.

    Token ownership levels should also be benchmarked. It is important to consider tenure and latest market valuation when evaluating ownership. For new hires, it is reasonable to target the 25th percentile because ownership levels will accumulate over time.

  2. Developing A Proposal: After the benchmark review, communities or councils will be well-informed to develop a pay proposal with outside experts.

    Communities or councils should also work with consultants to develop incentive plans for the upcoming cycle that achieve the organization’s short- and long-term objectives. For this exercise, it is important to include protocol leaders in the conversation as they have a better understanding of the organization’s strategy and performance drivers. When developing an incentive plan, it is critical to include performance metrics that are simple, measurable, and rigorous. C3’s next articles will cover “best practices” in performance-based pay.

  3. Approval: The community or outside consultant can submit the draft proposal to the community for a vote. The proposal should outline current pay levels and ownership, proposed pay levels and ownership, and rationale for any changes.

    If an incentive plan is utilized, the proposal should cover the details of the plan, such as the performance metrics, goals, and payout ranges.

Once approved, the organization can utilize the compensation model as a framework for broader employees.

Broader Employees

A similar process is conducted for other employees (i.e., non-leaders), with a couple of differences:

  • Less oversight from the community: A direct vote is not entirely necessary, especially when an elected council serves on behalf of the community. Additionally, protocol leaders should spearhead the evaluation for broader employees because they have a better understanding of internal job function and performance.

    A community-elected council can periodically report on token compensation expense or dilution for the entire organization. The community will therefore have a pulse on the aggregate token granting practices. A reasonable time to report on such provisions is when the council returns to tokenholders for budget requests.

  • Less variable pay: Protocol leaders can work directly with outside experts, like C3, to benchmark pay levels and ownership for lower-level employees. As mentioned above, the objectives of variable pay narrow as you move down an employee’s risk profile. Therefore, one can expect the percentage allocation to variable pay (i.e., bonus and tokens) to also decrease.

    Although the mix of variable pay may change, the overall design of incentives should be consistent with the design for protocol leaders so everyone is working towards the same goal.

A well-designed compensation governance process can go a long way because it gives the organization flexibility to evaluate compensation models by employee level.

Our next article will token granting best practices, and subsequent articles will cover performance-based tokens.

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The Crypto Pay Guide is a series of articles that will be authored and released by C3 over the coming weeks. C3 is the world’s first Crypto Compensation Consulting group.

We advise crypto organizations and communities on compensation levels, incentive design, and governance practices. We have experience advising both large public corporations and small technology start-ups.

Please read more about our firm and services on our website. If you are a leader, investor, or community member who would like to work with us, please contact us at info@c3.email or via Twitter.

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