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One overlooked reason Xero Limited (ASX:XRO) could keep winning

The power of incentives is one of the most overlooked drivers of a company’s future performance. As Charlie Munger says;

Never, ever, think about something else when you should be thinking about the power of incentives.” – Charlie Munger

How the people running a company get compensated offers enormous insight into what the company is trying to achieve and how capital will be allocated on shareholders behalf.

One company committed to incentivising high sustainable growth is cloud accounting platform Xero Limited (ASX: XRO).

New growth incentives locked in

Xero’s board of directors recently agreed to refresh the company’s executive compensation structure for FY19 which gives us a great view of the company’s priorities.

The new structure aims to reward results which meet Xero’s aspirations for growth and operational discipline to deliver long-term shareholder value.

The new short-term incentive plan looks well structured to me. It is weighted towards shareholder value drivers like subscriber growth and monthly recurring revenue (MRR) growth. However, it also factors in employee satisfaction and customer satisfaction which are essential for long-term success.

An incentive for risky behaviour?

Poorly designed incentives have been behind some of the largest frauds, failures and economic implosions we have ever seen. Just look at the recent examples:

  • Commonwealth Bank of Australia (ASX: CBA) disregarding anti-money laundering and counter-terrorism obligations (53,000 times…)
  • Wells Fargo bank employees opening fake accounts to meet aggressive sales targets
  • Accusations against Blue Sky Alternative Investments Ltd (ASX: BLA) of aggressively valuing poor performing assets to juice higher management fees

However, Xero’s board appears to have been mindful to structure the new incentive arrangements to drive “the right decisions and behaviours whilst promoting a culture of teamwork and innovation that will enable Xero to deliver sustainable growth for shareholders.

And I think they have. Half of the incentive payments to senior executives comes in the form of deferred equity in the form of restricted stock units, or RSUs, which are deferred for 12 months after the financial year and encourages longer-term decision making.

Foolish takeaway

Management incentives are often overlooked in the investing process. However, Xero’s recent incentives refresh suggests that the company will continue to aim high for sustainable growth going forward.

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Motley Fool contributor Regan Pearson owns shares of Xero.

You can follow him on Twitter @Regan_Invests.

The Motley Fool Australia owns shares of Xero. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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