The Basics of Executive Compensation

Executive compensation is in its own category for a reason. It differs markedly from typical pay packages for all other employees in that the amount of such pay is heavily dependent on metrics. For example,if an organization meets it annual goals while a given exec is at the helm, that executive will get a markedly bigger outlay. 

On the other hand, if the company misses important goals, that will be reflected in the exec’s pay. To look at this further, let’s check out the basics of executive compensation.

The Issue

The way executive pay is put together is meant to reward performance in keeping with shareholder value. Consequently, execs risk not seeing most of their pay if the company underperforms. The good news is that if all goes well, the executives and shareholders willbenefit from the performance.

Pay packages for executives usually have several common elements, including those below.

Base Salary

While the base salary for brass is typically referred to as annual, these execs usually get paid every two weeks or monthly, just like other salaried employees.

Depending on the company, industry, and the exec’s tenure with the company, compensation for top CEOs varies broadly. What we do know is that for the last 18 years, companies have only been able to deduct up to $1 million in cash compensation as a tax expense. This is the case for the CEO, CFO, and the next-three highest-paid execs.

Short-Term Bonus

Performance-based yearly incentives are meant to pay execs for meeting the organization’s short-term business strategy. Therefore, the “bonus” is dependent upon reaching objectives that were put forth by the company’s board.  Those annual goals may consist of improving profit margins, developing new goods or services, or putting in place a new corporate strategy.

Long-Term Bonus

The biggest chunk of executive compensation is the performance-based long-term incentive. The idea is to reward executives for knocking out strategic objectives that will help shareholder value. Here, we’re usually talking stock, stock options, restricted stock or performance-vested stock or options.

Benefits

Such programs for execs are akin to what’s offered to other salaried employees – Social Security, Medicare, etc. In addition to that, top executives can usually partake in special retirement plans such as nonqualified deferred compensation and supplemental employee retirement.

The rub is that such plans are exempt from federal tax and pension rules and usually aren’t secured by a trust. What all that means is that, if something befalls the company financially, the executive may be out of luck.

Perks

Such perquisites comprise extra pay for senior executives that aren’t offered to other salaried employees. These additions are usually put together to acknowledge the exec’s value to the company, the time sacrifices he or she makes and other special conditions.

These perks can include a primo parking space, company planes for personal travel, rides to and from work, financial planning, as well as security at home and when traveling.

Performance-Contingent Pay

Severance coverage pays executives if they’re terminated involuntarily — unless for cause. The idea is to encourage execs hired externally to leave a previous employer should the new arrangement go south.

Then there are those so-called golden parachutes, which pay execs if they lose their job due to a merger or sale. This extra protection permits executives to concentrate on merger or sale opportunities that would benefit shareholders without being too worried about their personal financial future.

So, those are the basics of executive compensation, which is structured to reward organization performance and line up executive compensation with shareholder value. Therefore, much of executive pay is “at-risk,” which is not a problem if the executives and the company do well.