Are your executives’ goals aligned with
those of your shareholders? One way to
be sure the management team carries out the company vision is to design a compensation package that awards executives
for meeting long-term corporate objectives.
Privately held companies can benefit from
adopting the same best practices that public
companies employ regarding executive
compensation.
“The goals of shareholders are to maximize
company value, and the executive management team must drive that value,” says
Christopher Meshginpoosh, director in
charge of the Audit & Accounting Group at
Kreischer Miller, Horsham, Pa.
“You can drive behavior with incentives,”
he says, emphasizing the importance of an
executive compensation package that
awards leaders for reaching short- and long-term goals.
Today’s well-rounded compensation plans
include more creative solutions than doling
out blocks of stock options to executives.
Here, Smart Business discussed with
Meshginpoosh how to structure an executive
compensation plan as well as the issues leaders should address before putting a plan on
paper.
How are executive compensation plans generally structured?
There are three basic components to any
compensation plan. First, there is base salary,
which should be fair in relation to other similarly situated executives. Second, there
should be a current cash incentive that
awards executives for short-term performance, such as meeting growth, profitability or
customer satisfaction objectives. The third
component, which is often overlooked, is a
long-term incentive arrangement. This is
essential for balancing executives’ focus on
short- and long-term goals. If management is
focused on driving earnings for the current
year and, in the process, sacrifices progress
toward meeting long-term objectives, executives ultimately will not meet shareholder
expectations. Without long-term incentives
— such as equity-based awards that vest
when goals are met — executives may lead
the company with nearsighted strategies that
leave shareholders feeling duped.
What are the first steps for designing effective long-term compensation incentives for
executives?
First, consult with an attorney, accountant
or advisers to find out how companies similar to yours structure their executive compensation plans. These third parties can provide valuable advice regarding overall compensation trends. It is essential that the plans
are properly structured on the front end to
avoid disputes or unanticipated accounting
impacts after the plans are implemented.
Don’t put pen to paper without doing this
homework.
What trends are we seeing in executive compensation today? What’s changing?
In the past, many long-term awards were
structured by awarding large blocks of stock
options that vested over time, regardless of
how the company performed. For example,
if an executive was on board for a defined
period of time, he or she was fully entitled to
the award and reaped its benefits as stock
prices climbed. Today, more and more companies are moving toward awards that vest
only if executives achieve certain predefined
objectives. These performance-based vesting strategies work with practically any equity
incentive including stock options, restricted
stock or other equity awards; however,
ensuring that the vesting conditions are
aligned with shareholder goals is essential.
What is necessary in order to create a plan
that aligns with shareholders’ values?
Start with defining shareholder objectives.
What are their goals for the company? Are
shareholders interested in top-line growth or
bottom-line growth? Are they seeking a
return through the sale of the business in the
not too distant future? Are they anticipating
international expansion? Define strategic
objectives first and, once there is broad
agreement on those goals, design a balanced
compensation plan that awards executives
for accomplishing both short- and long-term
goals — don’t just hand out bonuses when
annual financial targets are met or when an
executive celebrates five years with the company. Short-term goals and tenure milestones
do not inspire executives to propel a company’s long-term performance.
Who should structure and oversee the executive compensation plan?
The ultimate responsibility for the design
and approval of compensation plans resides
with the party responsible for governance —
whether it’s the board of directors, the compensation committee, the patriarch or matriarch of a family business, or the company
founder. Additionally, the CEO should be
involved in order to reach agreement regarding personal goals as well as the plans for
other executives reporting to the CEO.
Are there any other matters that should be
considered?
It is important to remember that the operating environment for most businesses is
constantly changing. This undoubtedly
results in changes in objectives, and it is
important to make sure that executive compensation plans are revised to reflect those
changes.
CHRISTOPHER MESHGINPOOSH is director in charge of the Audit & Accounting Group at Kreischer Miller in Horsham, Pa. Reach
him at (215) 441-4600 or [email protected].
