The time is now! Many health system are investing in innovation-focused strategies.
In this article, leaders from SullivanCotter and McDermott Will & Schulte show how these structures are taking shape and how these forward-looking activities require new compensation models tailored to the unique demands of these new leadership roles.
Contributing authors include John Collins, Principal, Kathy Hastings, Strategic Client Relationships Leader, and Bruce Greenblatt, Executive Workforce Practice Leader, from SullivanCotter; and Jeffrey Holdvogt, Partner, Kerrin Slattery, Partner and Michael Peregrine, Partner from McDermott Will & Schulte.
Originally published by the American Health Law Association
As health systems seek to increase financial stability, sustain growth and advance their missions in today’s dynamic environment, many are investing in innovation-focused strategies—developing centralized innovation centers and launching new subsidiary business ventures to diversify revenue streams. These forward-looking activities require thoughtfully structured compensation models tailored to the unique demands of innovation leadership roles, as well as to the incorporation models and monetization strategies of the newly created businesses.
Innovation Structures Are Taking Shape
Health systems are increasingly organizing innovation initiatives around two primary models:
Innovation Centers – These are centralized departments or businesses responsible for developing and executing innovation strategies across the health system enterprise. They often evolve from internal initiatives into more formalized structures with dedicated leadership whose purpose is to monetize internal innovation through patents, licensing, new devices or other technologies.
Subsidiary Companies – These are newly formed non-profit or for-profit entities incorporated to:
- Sell products, services, or technologies that may have originated from within the health system, been acquired, or resulted from partnerships with third parties.
- Invest in and then sell off to third-party portfolio companies, like a traditional venture capital (VC) or private equity (PE) investor.
Each model brings distinct governance, ownership, and strategic complications—and each requires leadership with specialized expertise that may come from outside the traditional nonprofit health care sector.
A Shift in Compensation Philosophy
Because of the different operational and financial objectives of these innovation entities, compensation strategies must adjust to reflect the realities of the talent market and business structure:
For Innovation Center Leaders, pay is typically benchmarked against comparable corporate innovation leadership roles in the nonprofit or for-profit sector. These individuals are responsible for setting and managing innovation strategy, with performance measured across the innovation portfolio based on overall performance.
For Subsidiary Company Executives, compensation is typically tied to the financial performance of the new nonprofit or for-profit subsidiary and often tied to an exit strategy (sale or IPO).
Regardless of the model, compensation should aim to attract top talent, drive performance, and align with the health system’s values and compliance obligations.
Managing Risk and Ensuring Compliance
Nonprofit health systems must navigate important legal and regulatory risks when forming for-profit subsidiaries and compensating executives involved in those businesses.
Key concerns include:
- Tax-exemption risks related to private inurement, private benefit, or excess benefit transactions
- Reasonableness of compensation, particularly when equity-based awards are involved
- Transparency requirements, such as reporting on IRS Form 990
Importantly, creating a for-profit subsidiary does not automatically shield the parent organization from regulatory scrutiny (and may, in fact, put a target on the parent organization). Compensation arrangements must be carefully structured, well-documented, and regularly reviewed.
Tailoring Incentives to Role and Structure
Several factors influence how compensation should be designed, including:
- The talent market, which may include candidates from the for-profit sector
- The organizational structure, whether embedded in the nonprofit parent or established as a separate entity
- The business strategy, including monetization plans
- The time commitment of executives with dual roles across the system and the innovation center or subsidiary business
For executives leading for-profit subsidiaries, the pay mix typically shifts toward performance-based compensation with lower base salaries and more significant variable pay, including more annual and long-term incentives.
Common structures include:
- Cash-based long-term incentive plans tied to earnings or return on capital
- Equity-based incentives (e.g., stock options, restricted stock, profits interest) for ventures with defined exit strategies
- Carried interest or similar cash incentives for subsidiaries operating like a VC or PE investor
Organizations with innovation centers should also consider applying payout caps or soft caps on pay to ensure that compensation can still be considered reasonable and not exceed the fair value of the services rendered.
Addressing Dual-Role Scenarios
Executives who serve both the parent organization and its innovation ventures present unique challenges.
In these cases:
- Incentives may be prorated based on time spent on innovation responsibilities
- Threshold time commitments (e.g., 75%) may be set for eligibility in innovation incentive plans
- Special bonuses or goal adjustments may be used for executives with partial responsibilities
Regardless of structure, total compensation must remain reasonable to comply with regulatory requirements and aligned with governance expectations.
Conclusion
As health systems increasingly pursue innovation as a strategic imperative, they must also modernize their approach to executive compensation. Aligning pay with innovation performance, market expectations, and regulatory compliance is critical to attracting the right talent and ensuring long-term success. With the right structure in place, organizations can drive meaningful innovation while remaining true to their mission and values.
About McDermott Will & Schulte
Leading organizations turn to global law firm McDermott Will & Schulte for a better way to address legal challenges, connect with those at the forefront, and drive stronger outcomes. Working across more than 20 offices globally, our 1,750+ lawyers act on data-driven insights, deep relationships, and unmatched industry experience to deliver on our commitment of Always Better.
About SullivanCotter
SullivanCotter partners with health care and other not-for-profit organizations to understand what drives performance and improves outcomes through the development and implementation of integrated workforce strategies. Using our time-tested methodologies and industry-leading research and information, we provide data-driven insights, expertise, and solutions to help organizations align business strategy and performance objectives – enabling our clients to deliver on their mission, vision, and values.