Customizing Executive Compensation

What resources and techniques are available in order to provide special compensation for key executives in light of IRC rulings and SEC disclosure requirements and the upswing in demand for highly qualified executives? Short-term incentive plans and long-term income programs are two major compensation techniques which still can be used to attract, motivate and retain top performers.
 
·          Specific objectives to be achieved by the company
·          Needs and desires of the participants
·          Type of ownership of the organization
·          Financial resources
·          Impact on the individual’s taxes
·          Accounting issues, in particular those affecting stock-based programs
 
Once all of these factors are known, the company is in a better position to consider which alternatives best meet their requirements, have the least onerous aspects, and then determine the specific plan or programs which would achieve the stated objectives.
 
Unfortunately, many firms get caught in a trap by adopting executive compensation programs without a full understanding of the implications and ramifications of those programs. These problems are often compounded due to overly complex and insufficiently communicated programs - which in turn lead to even more problems.
 
The cause and effects of the aforementioned problems are elaborated upon below.
 

"Me-Tooism"

A recurring failure among executive compensation programs is the adoption of seemingly solid incentive plans based solely on the fact that other organizations have similar programs.  Sadly, this "me-too" attitude is contagious, and also occurs when an executive attempts to install a compensation program from his old company into the current company.
 
What's good for the goose may not necessarily be good for the gander. As a matter of course, the original plan is often produced in response to one company's peculiar circumstances and needs.  Installing a parallel program in another corporation could be ineffective or even counter-productive.
 
Even within the same industry, each company is unique and its compensation solutions must also be designed  to  consider its uniqueness, management style, specific issues, financial resources, etc.  While some concepts are common within any compensation plan, some elements of the plan design are not: participation, award schedules, weightings of performance factors, etc.  These are unique to that organization and cannot be blindly applied to another one.
 

Lack of Cohesive Planning

Inherent in many compensation programs, particularly among small and medium size organizations, is an apparent lack of consideration of objectives or the cumulative effect of such plans.  Rather than having the various executive compensation plans fit together into one well-defined program, there are gaps and inconsistencies that are the result of a piece-meal approach to compensation.  Since there is not a cohesive direction for the plan, even with the best of intentions it will be analogous to a bunch of band-aids, rather than a systematic pay package.  Planning and forethought are key ingredients in a successful executive compensation program.
 
How does a company place itself in such a poor position? It evolves from the very roots of corporate compensation theory.  Employees provide the work for which they receive compensation.  In this basic economic formula, it is difficult to see where the flaws are.  The problems, however, are not in the equation but in the execution.
 
During the perpetual workings within our financial, political, sociological, and, to a small degree, religious milieu, businesses feel obligated or are coerced into inventing new forms of compensation. There is a never-ending impetus to stay competitive or to differentiate the company to make it more “attractive” as a potential employer.  However, these plans can outlast their usefulness and become obstructions.  This is particularly true when special plans are devised to accommodate one specific need among hodge-podge of different and often contradictory pay programs.
 
Top management - and, where appropriate, the Board’s compensation committee - must embrace a systematic method for developing executive compensation programs.  This includes careful planning in all stages.  Objectives of the program need to be identified and their continuing relevance considered.  The company must define its compensation philosophy to serve as the baseline for the development of all compensation programs.  Communication between the Board and management is a key factor in its success.  Best practices and alternatives need to be identified without falling into the “me too” trap.  Once all these steps are accomplished, the company can then design a program that satisfies all its needs and meets the objectives identified from the beginning.
 

Motivational Objectives

An all too frequent problem is the inherent shortage of motivational qualities built into compensation plans. Experience has shown that lack of specificity in the objectives and the individual's inability to make meaningful contributions turn many incentive plans into mere profit sharing plans, devoid of any true motivational benefits.
 
A company must be able to clearly define goals and objectives to motivate managerial skills and higher levels of productivity.  In turn, individuals must be held accountable and duly rewarded.  Many believe that the “Three Musketeers” concept – in which everyone works at their utmost for the benefit of the “corporate goal” – is sufficient motivation.  Unfortunately, experience has shown that, unless there is a coordinated communications process tied to a clear direction and objectives, the desired teamwork may not be enough to eliminate partisanship and a less than cohesive or effective effort. 
 
A meshing of corporate and functional objectives that clearly indicate the relationship between business unit goals, and the overall company tactical and strategic plan, on the other hand, may tie the desired results together in a much better way, and have a far greater impact at producing the desired results. 
 
Such a program easily can be constructed so that the executive’s incentive award would be based on accomplishment of his/her own functional objectives that lead to the achievement of company objectives.
 
It is obviously far easier to construct individual objectives for an executive with responsibilities such as bottom line profits.  Although more difficult, meaningful quantifiable objectives can be created for key staff functions such as human relations, finance, IT and administration. The accomplishment of both the individual and corporate objectives provides realistic justification for incentives.
 

Communications

Possibly, the greatest shortcoming of many executive compensation programs is the overall lack of communication.  Executive compensation information is disseminated to participants at least as well, if not better, than is found with other compensation programs.  However, we have found that most organizations fall far short of providing a comprehensive discussion of the plans to those affected – various aspects of executive compensation are discussed in a disjunctive and nonsystematic manner, not unlike the method in which the programs and plans were developed
 
It is imperative that participants completely understand the system.  They must perceive that the rewards are equitable and that the objectives that are realistic, and achievable (even if they aren’t easy).  Of course, they must also appreciate that the program is competitive.
 
If communicated properly, the strengths of one or more of the elements could provide a balance against the possible limitations of other aspects of the plan. For example, a company may be willing to accept the reality of a below competitive base compensation program because of their outstanding benefit and perquisite program, plus above average incentive potential.  The company's objectives, in this case, is to lower its fixed costs while providing a highly competitive and very motivational total executive compensation program. In this situation, the company would communicate the various plans as one comprehensive program.  The result would be a sound understanding by participants, with a corresponding high motivational value.