Executive Compensation Philosophy
First, establish a clear executive compensation philosophy. The philosophy should:
- Guide actions that determine how to compensate executives.
- Reflect the company’s mission, vision, values and culture.
- Identify the organization’s labor market and where it will position itself relative to the market.
- Describe how the organization will use various elements of compensation to create a pay mix that will help accomplish goals.
Defining the term “executive” is another key step in the process. Executives are generally those with substantial management responsibilities within the organization or one of its subunits.1 Some companies only consider C-suite employees to be executives (those with titles beginning in “chief”). Other organizations include vice presidents, directors, senior managers, etc. It’s vital to identify at what level someone qualifies as an executive within your firm.
Build Your Plan Design
Once eligibility criteria is defined, you should decide which elements to include in your compensation plan design. According to WorldatWork (a global human resources association), there are five key elements of executive compensation:
- Salary is the fixed amount paid to an executive for performing specific job duties. Market and peer analyses often help determine the proper salary. A market analysis uses data from third-party sources to determine the average pay in a given labor market. A peer analysis compares data from organizations that share similar characteristics (usually competitors). For nonprofit organizations, Form 990 can be a good data source. Proxy statements are helpful for publicly traded firms. Both market and peer analyses compare data on similar jobs in select labor markets. The executive compensation philosophy guides the organization in setting its base pay relative to the market. Many compensation elements are a percent of base salary, so it is crucial to get the salary right.
- Short-term incentives are variable payments that cover a performance period of one year or less. Rewards are tied to individual, department, division and company results, and often have the greatest influence on executive behavior. Short-term incentive plans set overall target award levels as a percent of salary. It’s common for them to have multiple performance goals and measures (i.e., return on revenue, customer satisfaction, employee engagement) that may or may not be weighted equally. For each measure, most companies specify a performance threshold, target and maximum, along with associated rewards. Most privately held companies use one to three performance measures in their short-term incentive plans.2 Depending on the number of measures you include, this type of plan can quickly become complex. The plan needs to be easy to follow and clearly link results to rewards. If these elements are missing, the plan likely won’t drive performance, which defeats its purpose.
- Long-term incentives are another form of variable pay. A survey of private, for-profit companies revealed that 96% offer short-term incentive plans. However, only 54% offer long-term incentives.3 This is likely due to their complex nature. Long-term plans typically cover a performance period of three or more years. Rewards are based on business results (like profitability and revenue). These plans can be a valuable retention tool given their magnitude and long-term appeal. Executives often view them as wealth creators that can build financial security.
- Employee benefits are an important element of executive compensation. Benefits include health and welfare, life, medical and disability. They also consist of paid time off, retirement and other coverages normally available to all employees.
- Supplemental executive benefits and perks are the final element of executive compensation. These benefits go beyond those permitted under qualified plans and typically aren’t performance based. Key components include retirement and financial planning, but these benefits usually represent a small part of the overall compensation package.4
Attract. Retain. Succeed.
Developing an effective executive compensation plan requires both analytical and creative thinking. We suggest reviewing these plans annually to ensure they are performing well and are in line with the market. If you would like to discuss areas of opportunity, SilverStone Group’s HR Consulting Team is ready to assist. We can help you assess and develop a compensation plan that can attract and retain talent while supporting your business goals and objectives.
1 WorldatWork (2014). Principles in Executive Rewards.
2,3,4 WorldatWork (2018). Incentive Pay Practices: Privately Held Companies.
This article originally appeared in the 2019 | ISSUE TWO of the SilverLink magazine, under the title “Executive Compensation: Is Your Plan up to Par?” To receive a complimentary subscription to the SilverLink magazine, sign up here.