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.

The Disruptors: 3 Revolutionary Aussie Companies to Back for 2018

We’re living in one of the most exciting times in investing history. Innovation and a booming culture of entrepreneurship are constantly creating new companies with the potential to make forward-thinking investors very rich. Now more than ever, one small, smart investment could make a huge difference to your wealth.

That’s why at The Motley Fool we’ve been scrutinizing the ASX to uncover the kinds of companies that we believe could turn into the next Atlassian.

We’ve found three exciting companies that we believe re poised to perform in the new year. Click here to uncover these ideas!

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.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss a very important event! Chief Investment Advisor Scott Phillips and his team at Motley Fool Share Advisor are about to reveal their latest official stock recommendation. The premium “buy alert” will be unveiled to members and you can be among the first to act on the tip.

Don’t let this opportunity pass you by – this is your chance to get in early!

Simply enter your email now to find out how you can get instant access.

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our Financial Services Guide (FSG) for more information.