Executive compensation Featured

8:00pm EDT September 25, 2008

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 cmeshginpoosh@kmco.com.