MANA 443 Compensation & Benefits

Case Study:
Equity on Demand: Netflix Approach to Compensation

Prepared By:

Chenjing Yang 26962335

Luyin Zhang 26369928
Claire Kelly 27425104
Alexei Richardson 26992889

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Yu-Ping Chen
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October 5th, 2017

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Question 1: Is compensation program consistent with company’s culture, strategy and

business model?
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Netflix’s compensation program reflects and supports the company’s strategic goals of a

high-performance culture through their competitive wages, choice of compensation package, and

a-typical benefits.

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 The employees receive top-of-market wages to encourage their high performance, as

Reed Hastings, the Netflix CEO, explains in the article “one outstanding employee gets more

done and costs less than two adequate employees” (5). The company encourages their employees

to take responsibility, one of the company’s main values, for their work and consistently exceed

expectations by rewarding them with high salaries. The compensation mix also supports culture

of high performance through minimizing “rules and bureaucracy that would inhibit [employees]

performance” (5). Through the ability to distribute their wage forms freely between salary and

stock options (up to 60% of their salary), employees are given a sense of freedom to decide

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which mix suits their needs best.

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Similarly, their corporate culture is sustained by Netflix’s unlimited employee vacation

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and flexible working hours, which enables employees to, without limit, decide their own working
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schedule.

The firm aims to retain “only outstanding employees” and boasts a very high involuntary
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turnover rate due to terminating all those who don’t measure up to Netflix’s performance
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standards (5). However, to be able to retain the remaining group of exceptionally skilled
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employees as well as to attract new top talent, whom are most likely receiving other concurrent
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offers of employment, Netflix developed the philosophy to “pay them more than anyone else

likely would, […] pay them as much as we would pay to keep them if they had a higher offer
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from elsewhere” (5). Meaning, Netflix doesn’t simply compensate their employees for their
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work, they do so with top-of-market wages with the intention of retaining and attracting skilled
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employees.

Lastly, employees are given the opportunity to design their own compensation mix at

both their hiring date and at the end of every year, with the ability to distribute their wage form

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 freely between cash and stocks (up to 60%) to best be able to meet their personal needs. Again,

this relates to Netflix’s desire to retain top employees with their flexibility and competitive

compensation strategy to ensure they continue to work for Netflix. Employees are also given the

opportunity to buy stocks every six months at a 15% discount – further demonstrating the

strategic internal alignment of Netflix’s compensation strategy with their high-performance

culture, as employees who are high performing will most likely influence the company’s stock

price and therefore reap the direct benefits of their hard work.

Question 2: In what ways is the compensation program more efficient than the standard
practice whereby the firm decides the compensation mix for employees? In what ways is it

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less efficient?

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As previously touched upon, Netflix’s values pertain around “freedom and

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responsibility”, allowing their employees to have say in their compensation mix allows them to
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have freedom of choosing but also the responsibility of understanding which mix would be most

effective for their personal motivation and lifestyle. Having such a compensation package that
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aligns with the values of the company will help attract and retain valuable employees to the
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company; specifically, ones that align with Netflix’s business values.

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Furthermore, creating individually designed compensation packages allows employees to

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feel as though they have the option to become more financially invested in the future of the

company; which pushes employees to take initiatives that increase the value of the company,
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benefiting both the employee and the company itself. With Netflix hoping to attract and retain
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employees will that go above and beyond and are able to self-motivate; having a compensation
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mix that creates the opportunity for employees to take responsibility for aligning their financial

interests properly and investing in the company will create a system that will help not only attract

valuable candidates but will minimize employee turnover. Turnovers are both timely and

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 expensive, and having a compensation package that motivates and invests employees in the

future of the company will hopefully reduce the amount of time and energy employers will need

to invest into their rehiring efforts.

However, allowing employees to choose a compensation mix can also create more work

and complications for Netflix if not done in a strategic fashion. If employees are given the

freedom to decide how much of their compensation is awarded in equity, the employers must

create a transparent environment around the current state of affairs of the business as well as

educate employees about how to strategically set their compensation mix and how the equity

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program functions. Netflix allows their employees the added bonus of changing their

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compensation mix every year, an option which is timely and expensive for the company. Since

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the employers are not in control of the quantity of stock each employee chooses there is a risk
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that the employer could give up a larger chunk of ownership than they initially planned for (ex. if

all employees opt for 60% of their salary in stocks). This can cause risks in the future for Netflix
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if they decide to sell the company, as buyers are more attracted to companies that have fewer
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stockholders.

The efficiency of allowing employees to choose their own compensation mix is largely
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based on the long term; retaining attractive employees and keeping them motivated is key to

ensuring they stay with the firm. This is a very appealing offer for many employees, and can
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differentiate your compensation package from others, but your company must be able to
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financially sustain this option and be flexible with the percentage of ownership it is willing to
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handout.

Question 3: What economic and behavioral factors might explain findings in exhibits 6 & 7

regarding:

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 A) An employee’s election to allocate a portion of his/her salary to stock options

Before Netflix’s 2006 change in compensation techniques, terminated employees were

required to exercise all stock options within 30 to 90 days within the date of termination. And,

according to Netflix’s CEO, Reed Hastings, the company aims to retain “only outstanding

employees” (5). While this goal results in the same overall average market turnover as most

other companies, there’s one key difference - their involuntary turnover is much higher at almost

“double the rate of [their] voluntary turnover” (5). With this in mind, before 2006 an employee

might have been hesitant to allocate a portion of their salary in stock options if they felt uncertain

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about their position at the company, due to being forced to sell off their stocks if terminated.

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However, post-2006 remodelling of Netflix’s compensation program, there are three

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reasons why an employee might elect to allocate a portion of their salary in stocks. In exhibit 6, it
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was ascertained that “female employees, employees with higher salaries and employees at the

vice-president level were more likely to participate” in the stock options (11). According to the
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article, stock options are used to attract potential employees who will add substantial value to the
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company - this would apply to employees at the vice-president level or those with higher
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salaries, assuming that they are higher paid due to a competitive market and their experience, as
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their higher pay insinuates that they have more to offer the company than an entry level worker.

Furthermore, employees who are higher up at a company tend to have more work
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experience, allowing them to have a better understanding of what they, as an employee, are
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looking for in an employer. This more comprehensive understanding may enable them to commit
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for a longer period of time to Netflix, and therefore be more willing to invest with the company

as they foresee themselves with the company for a longer period of time than the average

employee.

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 Lastly, “employees who received larger raises” tended to take part in the stock options

provided by Netflix. Referring once more to the company’s high turnover rate, employees with

strong performance are more likely to be kept on and may also be motivated by seeing their

performance directly impact the value of the company, and consequently their rewards.

B) Correlations between election to receive stock options and job performance.

In Exhibit 6, it is shown that “employees who were involuntarily terminated were less

likely to have participated in the stock program” in the previous year (11). While employees are

no longer forced to exercise their stock options upon termination, an employee who isn’t

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performing well is likely to be aware of the possibility of termination. An employee in this

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situation may decide to not invest in the company through stocks as they will soon no longer be

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part of Netflix, and may want said percentage of their salary in cash, a more liquid asset, for the
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time when they are looking for new employment.
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Comparably, employees with longer tenure were also found to participate less in the stock
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options offered by Netflix. This may be attributable to their position being guaranteed with the
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firm which makes them less interested in investing in stocks for profit as they will receive
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enough compensation through their guaranteed employment with Netflix already. In similar
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fashion, employees with longer tenure are most likely older in age, possibly with a family to

support, and therefore are interested in lower risk compensation packages.

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C) Decision of when to exercise stock options.

According to Exhibit 7, employees typically exercise their stocks before the 10-year term
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finishes, with “50% of stock options […] exercised in [the following] 4 years” (11). A possible

behavioural motivation may be the employees are concerned that the intrinsic value of the stocks

will slow in growth and possibly decrease, therefore hedging the risk and selling when their

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 stock options have a profit of 40-60% of the strike price (11).

Question 4: What changes would you suggest Netflix make to its current compensation

program?

While Netflix provides incredibly competitive and attractive compensation options for

employees, our team has four suggestions to improve their current strategy. To start, instead of

capping the stock options at 60% of an employee’s salary, the firm should limit the percentage of

stock options available to employees for those at different levels of the company. By making

different percentages of an employee’s salary open to stock options as they progress through the

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company, it will motivate employees to perform well and stay with the company to reach higher

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levels of investment opportunity with a brand that’s experiencing explosive growth. For example,

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entry-level employees can choose to allocate up to 20% of their salary, whereas a senior manager
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can allocate up to 45% of their salary in stocks. This would serve as a source of motivation for

employees and would also hopefully further decrease voluntary turnover; high-level managers
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and long-time employees are important for the firm as these employees have a strong
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understanding of Netflix’s corporate culture and history. A lower turnover rate also decreases the
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amount of time that needs to be allocated to training new employees, which in turn decreases
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costs. Overall, the goal is to further motivate and retain top employees through the goal setting of

stock options available to an employee.

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Secondly, we propose a variation in Netflix’s vacation policy - currently, the company

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employs an unlimited vacation policy for all employees. We are not interested in changing said
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policy, however we propose to reward employees who limit their vacation time, for example

taking less than 10 vacation days per year, with an additional add-on to their salary during the

end of year review.

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 Finally, Netflix can implement a student loan assistance program that employees are

eligible for after a predetermined number of years of working for the company. By doing so,

Netflix is increasing their knowledge base and their opportunity for profit through innovation

and being at the forefront of the industry. Similarly, Netflix places value on a high-performance

culture and by investing in employees’ opportunities for education, they are improving their

business processes and workplace efficiency.

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