CEO Best Practice: Executive Compensation

Executive Tools

• Executive Summary
• Self Assessment Checklist

Expert Practices Articles

• Six Steps to an Executive Compensation Plan
• Executive Compensation Tools
• The Fundamentals of Plan Design
• The Players in the Plan
• Retirement Plans: A Non-Qualified Success
• What to Look for In an Executive Compensation Firm
• The Do's and Don'ts of Executive Compensation Plans

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Six Steps to an Executive Compensation Plan

A good executive compensation plan aligns the behavior of your senior managers with the strategic goals of the organization. Price believes that executive compensation plans give back what laws, regulations and "bracket creep" take away as people move up the pay scale. Finally, says Few, executive compensation plans help to maximize business value, provide a transition strategy for ownership and management, and enable shareholders to realize their equity.

To design and implement an executive compensation plan, our experts recommend a six-step process:

1. Conduct a current-state assessment. Start by asking questions like: In terms of compensation, where are we as an organization and where are we trying to go? How do we believe in rewarding people for the company's success? What does our strategic plan suggest in terms of the most effective types of executive compensation?
2. Establish plan goals and objectives. Ask: What is the purpose(s) of this plan? What do we hope to accomplish? Are we attempting to modify behavior or simply reward outstanding performance? Do we want to focus on specific performance objectives? Is so, which ones? In this step, most (if not all) of the answers will come straight from your strategic/business plan.
3. Determine who participates. Identify plan participants based upon a combination of individual and organizational criteria.
4. Design the plan. In addition to all the considerations involved in the first three steps, suggests Few, plan design must also take into account the following factors:

• A wide variety of compensation tools and techniques
• Monitoring, measurement and reporting issues
• Tax, legal and accounting issues
• ROI goals of the owner/shareholders
• The exit strategy of the owner (in a privately held firm)

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Executive Compensation Tools

Crafting a workable plan involves finding the right mix among these disparate elements. When putting together your plan, our experts recommend the following:

• Start with realistic expectations. Pick two or three strategic objectives and focus on those, gradually increasing the scope of the plan as you experience success.
• Talk to your people. Ask your executives what they're looking for in terms of total compensation. Find out their motivational and financial drivers.
• Use financial modeling. Build financial models to test the potential impact of the different allocations on your cash flow, financial statement and balance sheet.
• Enlist the aid of professionals. A good consultant can help you determine the right mix for your company and offer sophisticated tools and systems for engaging in the financial modeling process.
• Adjust the plan on a regular basis. Once a year, revisit your plan and adjust accordingly.

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The Fundamentals of Plan Design

When putting together an executive compensation plan, start by focusing on the following core issues:

• Cash compensation. Specifically, how much of your executives' cash compensation should be guaranteed and how much should be at risk through incentives?
• Demographics of your executive group. The age, experience and personal financial objectives of your executive team will play a major role in determining your compensation goals as well as the specific tools used in the plan.
• Company growth stage. Are you young and growing fast or have you reached a mature stage? This key issue will affect your strategy and approach as well as budgeting issues.
• Financial strength. Do you have the profits and cash flow to finance the plan?
• Growth model. Credible plans require a believable pro forma that outlines where you expect the company to be in three, five and 10 years.

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The Players in the Plan

Our experts believe that plan participants are best identified through a combination of individual and organizational criteria, including:

• Your compensation philosophy and organizational culture
• The goals and objectives of the plan
• Your company's financial resources
• Base pay
• Job responsibilities

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Retirement Plans: A Non-Qualified Success

In general, a qualified plan must be offered to all eligible employees and carries strict limitations as defined by ERISA (Employee Retirement Income Security Act). From a tax standpoint, it offers numerous benefits, including tax deductions to the company and tax-deferred earnings to the individual.

In contrast, non-qualified plans are not constrained by ERISA requirements. They offer significant design flexibility and the ability to discriminate among plan participants. For purposes of compensating senior executives, our experts agree that non-qualified plans are the way to go.

In the second broad category, our experts lean toward defined contribution as the plan of choice, especially for smaller, privately held companies.

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What to Look for In an Executive Compensation Firm

In general, compensation consulting firms offer assistance in four areas: initial assessment, plan design and implementation, communication and plan administration. The services you use will depend on a variety of factors, including your budget, size and scope of the project, and your preferences regarding communication and administration issues.

According to Price, an initial assessment to determine whether you have clear and realistic executive compensation goals can run from $5,000 to $10,000. After that, design, implementation and follow-through on an executive compensation plan can range from $5,000 to $50,000. For most TEC-size companies, Few and Miller estimate a ballpark figure of $15,000 to $30,000 to assist with the design and implementation of a plan.

To find the consulting firm that best fits the needs of your company, Miller recommends carefully evaluating the company according to size, cost/fee structure, experience, credentials and references.

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The Do's and Don'ts of Executive Compensation Plans

When it comes to executive compensation, say our best practices experts:

• Keep it simple
• Align the plan with your strategic goals
• Make the plan visible and accessible
• Provide financial education for your senior managers
• Plan for the long term
• Revisit the plan on a regular basis

Don't:

• Go overboard with complicated measurement and payout formulas
• Build your plan around a specific product
• Underestimate the tax/accounting issues
• Try to fulfill every individual need

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