How to craft an executive compensation plan Featured

9:01pm EDT October 31, 2011
How to craft an executive compensation plan

A competitive compensation package is essential to attracting and retaining high-performing executives. In addition to base salary, such a package ties performance to bonus and incentive awards as well as supplemental retirement packages, and includes provisions for severance pay.

Understanding the principles of compensation packages is critical when competing for top-level talent, says John Klevorn, a partner with The Stolar Partnership.

“From the company standpoint, hiring the right executive is incredibly important for the lifeblood of an organization,” says Klevorn. “You want to make sure that you have the right leader in place.”

Smart Business spoke with Klevorn about executive compensation, how to benchmark benefits and how recent reform has impacted executive compensation policies.

Where should a company start when negotiating executive compensation?

Executives come with hefty demands in terms of salary, benefits and other perks. Before you initiate a talent search or begin compensation negotiations, it’s important to establish a benchmark so that when you do begin to negotiate, you have a point of reference. Next, determine the level of proficiency and performance you’re seeking. With this information and the compensation benchmarks, it will be easier to search the marketplace, look at databases and understand the market value for the position.

There will be ranges with regard to market value so you will want to land somewhere inside those market value ranges. In some instances, a company will want the right person to grow into the job, so it might pay at a lower salary level within that range. In other cases, a company might want a star, and that star may only commit if he or she receives compensation at the high end of the market range.

How should a company benchmark benefits?

Make sure you’re compensating your executive fairly relative to the market. At the same time, make sure compensation is not so far askew internally that the incoming executive’s compensation compared to the next level below is out of whack. You don’t want to create such disparities within the company to cause employees to say, ‘Not fair, not fair.’

There is also an external aspect. Take financial services, for example. If you look at the compensation of CEOs of major financial institutions, you’re going to see symmetry. Company X does not want to pay its executive three times the amount that Company Y across the street is paying.

There is no collusion, but they do look at external matrices and metrics to remain competitive. Executive benefit companies monitor this information and keep their eyes on the latest figures.

You also want to make sure that the package you’re offering is not so diverse compared to other companies that the shareholders become concerned that the value of the company is being diminished.

What types of compensation programs are most effective at attracting and retaining executives?

First, the base salary has to be competitive. Second, executives want to know about bonuses. Are bonuses performance based? What standards will apply? Will bonuses increase over time? Stock options are also a key consideration.

Also, executives are often interested in longer-term plans. For example, add-on 401(k) plans allow those at the top to contribute more into the plan than other employees. Additionally, supplemental executive retirement plans (SERP) are designed to provide enhanced benefits to corporate executives and some are insured through life insurance programs and policies.

Are there laws to be considered when setting an executive’s salary?

You have to follow the standard array of laws. You can’t discriminate on the basis of race, age or gender. You can’t retaliate. Tax rules tell you that any compensation must be consistent with the ordinary and necessary business needs of the company. For example, if you manufacture widgets and employ 15 people, it would be difficult to justify paying your CEO $5 million per year because it would not be deemed ordinary or necessary by the IRS. Also, you need to make sure you’re not diluting the value of the shareholders’ interests, as they have a say in making sure their rights are protected.

Other than these basic rules, however, executive compensation is fairly unregulated.

How has the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 affected executive compensation policies?

Dodd-Frank imposes new executive compensation rules and appropriate governing requirements on publicly held companies in the United States. The government is taking the stance that, for the protection of companies, employees and shareholders, it is necessary to monitor executive compensation.

Executives have negotiated multimillion-dollar compensation deals both during their tenure and after they leave their companies. Dodd-Frank is designed to provide better disclosure regarding these. There are now nonbinding shareholder votes at least every six years with respect to regular compensation and golden parachute arrangements.

Because the votes are nonbinding, there has been discussion about the possible impact. If shareholders overwhelmingly state that they do not believe the compensation paid to their CEO is the correct amount, boards of directors will be inclined to listen. The Dodd-Frank Act also includes rules that deal with the independence of compensation committees and their ability to hire legal counsel and consultants. The independence clauses are a result of what happened with Enron, Tyco and others. Nobody was independent; they were all part of the company, and their subjectivity was high and their objectivity low. The result: no one was able to blow the whistle.

The Dodd-Frank Act was designed to provide better information about what’s going on inside companies.

John Klevorn is a partner with The Stolar Partnership. Reach him at (314) 641-5179 or rjk@stolarlaw.com.