August 29, 2009

How to Design an Executive Compensation Policy

By Staff Writer

If your company is looking to bounce back from a drop in profits or handle a growth spurt, you may be in the market for fresh talent at your executive level. What’s the best way to approach salary negotiations during the executive hiring process?

In a recent Webinar for Payscale.com, HR expert Sharon Koss, SPHR, CCP shared valuable ideas for executive compensation planning, and information regarding the search for top level executives. The following is a summary of her advice.’

Executive Compensation – Earnings

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Ms. Koss began with some interesting facts found in HR consultant Bruce Ellig’s book, “The Complete Guide to Executive Compensation”:

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Executives are the top five to seven positions within a company and usually encompass two to three percent of the total workforce.
Ihe United States executives earn 250 times more compensation than the average employee within a given company. That is not the norm at non-profit organizations, which historically pay their executives 50 times the average employee.
In anada and internationally, for-profit companies are much closer to the American non-profit model when deciding executive compensation levels.

Aligning Your Executive Compensation Policy and Hiring Strategy

Unlike most employee salaries, which are determined largely by knowledge, skills and experience, executive compensation requires consideration of more factors, such as current standard of living, time away (or sabbatical), and relocation concerns.

Ms. Koss recommends the following steps to HR professionals when developing an executive compensation policy:

Research pay. Use salary surveys to find out what other companies in your region and industry pay their executives.
Share your findings. Before you begin the hiring process, present the results of your research to the board of your company and seek recommendations regarding future growth projections, expectations, and short- and long-term incentive plans.
Write a job description. After hearing the recommendations from the board, write a job description based on the needs of the organization. This document can provide you a basis with which to begin your search.

Finding the Right Executive

While most executive level folks have track records of success, it’s important that you find the person who will suit your company culture and goals best. Ms. Koss points out that there are some common traits amongst executives. Ninety-seven percent of them have bachelor’s degrees and/or further education and a large number of them stay with one organization for 15 or more years. Lastly, the majority of executives come from the operations side of the business as opposed to the marketing, finance, or sales side.

Ms. Koss reminds you to keep your search for a new hire broad because the right candidate may not currently work in your industry. Some executives cross over industries depending on the needs of the company. She points out that executives with finance or human resources backgrounds are more likely to cross over industries because of the general nature of their expertise. As for marketing, organization, and sales executives, their work requires a more intense focus on their product and industry and they are less likely to cross over.

Types of Executive Compensation

Through your research you might find that companies compensate differently according to their needs or their industry. After researching typical approaches to executive compensation, as well as your own company and industry, you can then put together an executive compensation policy based upon a combination of the categories below:

Base salary. The base salary should reward the day-to-day activity of your executive. Some call this “merit pay” or payment for knowledge, skills and abilities. A question Ms. Koss recommends you ask yourself is, “Is the base pay fair?” What she means is that, generally, executive pay is most influenced by the number of employees in an organization. But, not only the current employees but future employees, too. She stressed considering organizational scoping factors to project how many employees your executive will be responsible for leading many years down the line. This means including the board’s projections of future growth or downsizing when determining base pay.
Executive bonuses. Ms. Koss points out that bonuses are commonly given annually and are 40 – 50 percent of the base salary. There are also companies that pay out quarterly bonuses of up to 20 – 25 percent of base salary. This means that some executives can get up to 100 – 150 percent of their base salary in bonuses.
Long term incentives. Long term incentives may come in the form of stock options or cash rewards. They encourage executives to stay at the company and pursue long-term objectives.
Supplemental executive retirement plans (SERPs). Supplemental executive retirement plans provide ways for executives to manage their income long-term, beyond typical 401k or IRA plans offered to most employees. They often are a combination of 401k or IRA plans, stock options given out over a number of years, and profit sharing in matching funds or just a strict predetermined payout.
Change in control (CIC). CIC agreements are designed to give peace of mind to the executive in the event of a separation. They secure bonuses and severance and give a payout timeline.
Deferred compensation. Deferred compensation is compensation (bonus or salary) that is given at a later date, after the actual bonus and salary is earned. This delay minimizes tax burden.
Extra benefits/perquisites. In addition to cash, executive compensation can include added perks, such as special parking spaces or club memberships.
Work environment. Quality of life factors are a relatively new form of compensation for executives. These can include shortening the executive’s commute by creating a separate office location for them or creating a work-from-home agreement. For example, Ms. Koss mentioned an executive compensation package she had worked on which stated that the CFO had to show up at the CEO’s home at 8:30 am every Saturday morning for a meeting regardless of holidays.

Executive Compensation Case Study – Using Organizational Scoping Factors

At the end of her executive pay webinar Ms. Koss, along with Stacey Carroll, director of customer service and education for PayScale, Inc., shared the story of a company that Ms. Koss was currently working with to hire a new executive. Ms. Koss wanted to demonstrate how to include organizational scoping factors when determining compensation policy.

Using PayScale Insight, Ms. Koss and Ms. Carroll compared the difference in compensation for the current company’s situation and the compensation of an executive in their projected, future situation.

Current status. The company is based in Tacoma, Wa., a mid-range market with a population of under a million people. The company is a manufacturing firm with 98 employees and 2009 revenue of $20 million.
New opportunity. The company needs a new CFO. They recently won a large contract from the United States Air Force. This contract would expand their employee base to a projected 276 employees and revenue of $95 million in 2010 and $150 million in 2011.
Special challenge. The current CEO and president are both founders and engineers, not finance experts. The new executive would not only serve as CFO through an exponential growth period, but would also advise the founders through the period and act as treasurer to a board with more than 20 members. Another challenge is that the members of the board have no experience with executive hiring or compensation.
Compensation research. Ms. Koss was brought in to aid the founders and board in determining their executive compensation for this new CFO position. Using PayScale Insight, Ms. Koss was able to pinpoint what a CFO in the manufacturing industry makes in Tacoma and the pay range in which they fall.
Final solution. During the webinar, Ms. Koss and Ms. Carroll focused on the total cash compensation (TCC) – without stock options or fringe benefits – for this position. PayScale Insight showed that the average CFO in an engineering firm in Tacoma, Wa. with 98 employees received TCC of $126,000 per year. When the search was changed to 276 employees, the annual salary increased to $196,000. A $70,000 annual difference is significant in both the executive’s life and the growing company’s books.

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