How to Build a First-Rate Executive Compensation Plan

Posted by Judith Mewhort on Mar 29, 2018 10:00:00 AM
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In today’s tight labour market, finding and keeping employees is a challenge, but the demands of attracting and retaining executives for C-Suite positions is even greater.

And let’s face it, the key to your company’s prosperity largely lies with the quality of the senior leadership. So, what elements should be considered and included in a successful executive compensation plan?

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The Importance of Executive Compensation: The Executive’s Point of View

Historically, senior leadership often receives compensation based on how well the company is doing. It’s generally based around company financial goals or maximizing returns to shareholders.

Much of Executive compensation is performance based. This can involve complex calculations or devoting a significant portion of pay to long-term incentives.

However, in many cases, these programs do not align with what executives want. A report from Price Waterhouse Coopers found that:

  1. Executives are risk averse preferring higher base pay even if it means lower overall compensation
  2. Complexity and ambiguity in plan design of incentive pay destroys value.
  3. The longer the deferral period, the less the incentive is worth.
  4. Fairness, relative to peers, is fundamental.
  5. People don’t just work for money.
  6. The key motivation of a long-term incentive plan is recognition.

Getting Started: Plan Design Tips for Effective Compensation

How do you design an executive compensation structure that attracts and retains quality talent? In addition to taking your corporate culture and desired outcomes into account, it’s important to keep the following in mind:

  1. Executives discount the value of performance pay by up to 50% for long term incentives.
  2. Keep it simple. The more complicated the performance matrix, the less valuable the incentive.
  3. Know your people and pay them accordingly. One size doesn’t fit all.
  4. Recognition matters as much as financial incentives.
  5. Large amounts of volatility in compensation from year to year is not appealing.

What Are Some Key Executive Compensation Components?

Unlike most salaried or hourly staff, the pay packages of C-Suite employees consist of several areas. As we mentioned, often a large portion of pay is designed to align senior management performance with company goals, share value, or corporate financial performance. However, it’s also important to consider that executives are very different from the majority of employees in other ways.

Higher Income Level Means Executives Need Greater Benefits

Due to the higher level of pay that executives receive, employers must think about providing additional life and disability insurance benefits that are reflective of their higher incomes. Standard group benefits in these areas will leave an executive woefully underinsured.  

Saving for retirement is also a challenge. The limits of registered retirement plans restrict the amount of pension plan or RRSP savings that an executive can accumulate. This results in a real need to find other savings or investment opportunities.  

The most common investment opportunity is shares. This is because there are a limited number of long term deferral vehicles available under the Canadian Tax Code. Also, stock option plans help align executive compensation with corporate performance. Unfortunately, reliance on stock option plans often mean that the executive has too many eggs in one basket: their job, lifestyle, and retirement are all relying on one source.

Employers can take action to mitigate this risk, including offering:

  1. Supplemental Retirement Plans (SERP)
  2. Retirement Compensation Agreements

Both of these offer a structured plan, which is kept separate from the employer’s operations. This ensures the benefits will be available in the future.

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The Nature of the Job: Executives Are Under More Pressure

In addition to higher income, executives experience greater stress, more travel, and potentially greater risks in carrying out their duties. Because of this, employers should consider offering additional and different benefits - not just higher levels of the standard benefits offered to the majority of employees.

Specialized benefits may include:

  1. Business travel insurance
  2. Comprehensive medical assessments including access to out of country specialists
  3. Generous health care spending accounts
  4. Wide-ranging wellness accounts
  5. Home purchase loans
  6. Club memberships
  7. First-class air travel
  8. Financial/tax/estate planning services
  9. Assistance with education expenses for children

Company Stage: Is the Executive Also a Shareholder?

Finally, when designing a executive compensation program, two important things to keep in mind are the development stage of the company--is it a start-up or fully mature—and the company size. In many small and mid-sized closely held corporations, the executives are also the shareholders or key people.  When you design compensation plans for shareholder employees, ensure the programs are carefully structured so that Canada Revenue Agency doesn’t deem them as shareholder benefits rather than employee benefits.  

Conclusion

Compensation and benefits are top of mind for all employees, especially top executives. According to the PWC report, retention is worth paying for as: “unwanted turnover in the senior ranks has a cost to the organization”. This can include hard costs such as executive search fees and replacement costs for “trickle-down turnover” in reporting positions, as well as soft costs such as the organizational distraction that happens during a top-level change.

Don’t take a passive approach to executive benefits. There is too much at stake, including the ability to effectively recruit, retain, and reward the people who will take a major role in your company.

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