Executive Compensation Planning
Compensation Strategies for Executives & Entrepreneurs
Top talent commands top compensation and superior performance deserves just rewards. These principles are reflected in today’s lucrative pay packages for executives at public and private companies. Whether you own a business and compete for these employees, or are an executive offering your services to a corporation, it’s important to understand the universe of compensation packages used in today’s competitive marketplace.
As any owner or general manager of a professional sports franchise can confirm, offering a competitive salary is only a starting point for attracting and keeping quality players. Supplemental perks, such as a signing bonus and luxury travel accommodations, are routine add-ons. In addition, superstar athletes generally receive bonuses tied to performance — such as number of hits in baseball, or number of yards gained for a running back in football.
Similar principles apply in the world of business when companies compete for the services of highly valued executives or specialists. Most employers pay their key employees in three ways: It starts out with the salary, then an annual bonus, and finally with one or more long-term incentives usually tied to specific metrics, such as value creation, or achieving specific goals over a multi-year period of time.
In both public and private companies, the trend over the past two decades has been to align the financial compensation of executives and key employees with the success of the overall business. One notable method to give executives a stake in the ownership of the business, is through stock options grants. Even now that companies must account for these grants as an expense, they remain a major component of pay packages, particularly at public companies.
But options grants are only one way of putting the interests of an executive in sync with the financial performance of a company. Several other compensation strategies may serve as superior alternatives or logical complements to granting options.
- Phantom Stock. Many owners of private companies may find it difficult or undesirable to issue stock because of the dilution of ownership and additional burdens of governance involved. In such cases, phantom stock may be a viable alternative. Phantom stock doesn’t dilute ownership, since the executive is not given actual equity in the company, but rather a future cash bonus based on the company’s value. The business owner and the executive need to agree on some way of valuing the business, such as book value or a predetermined multiple of discounted cash flow, operating earnings or EBITDA. (Earnings before income, taxes, depreciation, and amortization.)
- Stock Appreciation Rights (SARs). While they’re similar to phantom stock, SARs differ in they are sometimes paid out in actual company shares. A contractual arrangement between a company and an employee granting a value equal to the appreciation of a specific number of shares over a period of time, SARs are often issued in tandem with stock options to help employees fund the options purchase. Like phantom stock, SARs are treated as taxable income to the employee when payments are actually received.
These are both great ways to provide performance incentives for employees, but the business owner needs to plan ahead to have the liquidity to redeem them at the end of the vesting period. Of course, these and other long-term incentive plans are treated as non-qualified deferred compensation plans and employers need to be mindful of following Section 409(a) of the Internal Revenue Code when using them. Other compensation options to consider are; Global Executive Compensation Issues, Long-Term Cash Incentives, Long-Term Incentive Plans, Performance Metrics, Performance Shares, Perquisites, Restricted Stock, Severance and Change-in-Control, and Short-Term Incentive Plans.
Another popular perk for executives is allotting money to pay for professional services, such as attorneys and financial planners. If your employer provides this perk, take advantage of this option. It’s one less thing for you to worry about.
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