February 28, 2011

The ABCs of Executive Pay

What are the ABCs of executive pay and why is it so different from what the rest of us get?

Who Gets Executive Pay?

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Usually only those members of your most senior management team qualify for executive pay. It is usual the members of the “C-Suite.” By title they typically are:

• Chief Executive Officer
• President
• Chief Operating Officer
• Chief Financial Officer
• And other Chief Officers, such as Chief Information Officer or Chief Marketing and Sales Officer

What Are the Components of Executive Compensation?

While a non-exempt employee earns simply an hourly rate and, hopefully, a benefits package that includes basics such as medical, paid time off, and a 401(k) option, the components of executive pay are more numerous and more complex. They include, but are not limited to:

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• Base salary
• Incentive pay, with a short-term focus, usually in the form of a bonus
• Incentive pay, with a long-term focus, usually in some combination of stock awards, option awards, non-equity incentive plan compensation
• Enhanced benefits package that usually includes a Supplemental Executive Retirement Plan (SERP)
• Extra benefits and perquisites, such as cars and club memberships
• Deferred compensation earnings

What Is Executive Compensation Based Upon?

Most organizations have separate executive pay plans and these plans focus much more on the individual, where it is the person for whom the compensation package is tailored. The executive pay packages must still be consistent with the compensation philosophy of the organization. They must be competitive in terms of what is being offered to similar officers within the same industry and in comparably sized organizations. Whereas geography is a huge factor in terms of prevailing wages for non-exempt employees, at this end of the pay spectrum geography is not as an important factor. Recruitment at this level is usually at the national, or even international.

Why Is Executive Pay a Big Deal?

Why is executive pay harder and require more considerations? Executive pay is complex for a number of reasons, which include tax minimization, financial reporting, and government regulations. While most of us are left on our own to deal with Uncle Sam and the taxes we owe every April; effective executive compensation plan designs look at the current tax laws and take those laws into consideration. Plan updates are made when favorable tax benefits are found.

The Sarbanes-Oxley Act (SOX) that passed in 2002 enhanced financial disclosure and put limits on what can be offered to executives of public companies. SOX stopped loans to executives, for example. The Financial Accounting Standards Board (FASB) has determined that stock options must be reported on financial statements as an expense. The combination of SOX and FASB regulations has made stock options granted a less popular element of the total reward mix.

What Do I Do If I Need to Design Executive Pay for My Organization?

This is not an undertaking for the inexperienced to take on by themselves. This is the time to call in an expert and partner with your finance department. The total rewards package for your executives needs to be reviewed by your legal counsel and satisfy your executive pay committee of your board of directors. You must assure that sufficient employment, severance, and change of control agreements are in place to meet the needs and goals of the organization. Concurrently, your executive pay plan needs to have clearly understood corporate-wide measurements to maximize the compensation investment being made. It is critical to get this pay right for the good of your executives, as well as the health and leadership of organization.

Regards,

Beverly Dance
MBA, SPHR-CA, CCP, CEBS
Principal, Dance Associates
dance@mba.berkeley.edu
Human Resources Consulting

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