Company executives make important strategic decisions and goals, and coordinate organizational operations. Having your key employees head-hunted by another organization can be a nightmare for your business, whether you’re a privately-held company or a publicly-traded company.
It is important to structure your executive compensation plan right to keep them happy and motivated. Here, we’ll discuss:
What is executive compensation?
Executive compensation, also known as executive pay, is the combination of salary, benefits, and bonuses offered to executives or other top management positions at a company in return for their work.
As they are experienced and skilled professionals at the top of their respective industries, companies often compensate them with a more valuable and complex compensation package.
Why is it important to discuss executive pay?
Executive compensation structure has been widely discussed because it’s important to get it right due to :
- War for executive talent: Approximately 60% of private firms polled compete against public companies for executive talent according to the compensation policy surveys completed by several consulting firms.
- Talent retention: Executives or senior management, as mentioned, are key to a company so a well-designed structure helps maintain staff stability and thus grows the company and business profit.
- Public sentiment: All public companies are required to disclose how much they are paying their executives and how this amount is derived. Not getting it right can bring a lot of public attention.
- Regulatory: An executive compensation policy of publicly traded companies is overseen by governmental regulations.
- Board of directors: Boards may have concerns about their role in the approval of compensation packages.
What are the components of a typical executive compensation package?
A typical executive compensation package has financial and non-financial components. They are salary, benefits, bonuses and equity. Commonly, an executive would get more amount of equity than a normal worker and a normal worker quite often wouldn’t get any equity in a private company.
- Salary: A fixed yearly salary, also known as a base salary
- Benefits: They may include insurance (e.g. health insurance and life insurance) and perquisites (e.g. club/gym membership and other company mobile phones)
- Bonuses: Considered short-term or annual incentives, they’re usually non-fixed, one-off sums of money, based on KIPs
- Equity: Considered a long-term incentive (over 3 years), equity compensation represents a form of ownership in the company and motivates employees to work harder – the better the company performs, the better their own shares get! It also provides a way to significantly grow an individual wealth compared to fixed cash bonuses. Check how it works in the next section.
Executive compensation structure: Salary constitutes 30% of total compensation, bonuses another 20%, benefits about 10%, and long-term incentives (equity) of the compensation about 40%. (Source: Deloitte)
How does executive equity compensation work?
Equity operates quite differently from cash. You don’t fully own an equity award until the vesting period has passed. Vesting is the process by which you gradually earn full ownership of their equity through satisfying certain requirements – time-based and/or milestone-based.
Thanks to this built-in retention function, you will likely stay in a company longer to receive the benefits. Here are some common executive equity grants:
- Stock Options provide you with the right to purchase a certain number of shares at an initially agreed price at a future date after vesting.
- Restricted Stock Units are a promise from your employer to give you shares of the company’s stock as soon as you vest. So the employee doesn’t own them or become a stockholder with voting rights at the start.
- Performance stock vest based on performance targets such as financial metrics.
Executive compensation plans for private companies and public companies
Accordingly to the AON survey 2019, executives at public companies receive around 40% more compensation than those at private businesses. The driving factor behind the gap is the prevalence of long-term incentives at public companies while cash compensation is only slightly smaller for private company executives.
More differences are as below:
Don’t offer equity very often (due to no or little liquidity)
Offer equity more often
A small number of executives receive significant equity stakes
More executives receive equity, even managers
Offer less competitive equity-based incentives
Usually offer more competitive equity-based incentives
LTIP heavily relies on cash
LTIP tends to diversify awards among at least 2 equity vehicles – restricted stock & performance shares
Simpler processes for obtaining approval of equity grants
More time-consuming approval processes
Public disclosure of executive compensation plan is not required
Concise and understandable public disclosure of executive compensation plan required**
Since there’re many differences in executive compensation between private and public companies, make sure to allow yourself sufficient time to review your compensation plan if you intend to go public. To learn more, read our ‘’IPO executive compensation’’ checklist.
So, what is the most effective executive compensation structure?
The most effective executive compensation structure should be aligned with the specific business goals and strategy, the time horizon of the investors and other factors like below:
- Business philosophy, mission and vision
- Life cycle, organizational structure and business processes
- Workforce composition and demographics
- Tax and accounting regulations
- Industry and competition
- Public sentiment
After carefully considering them, you’ll know whether you should rely more on equity-based awards or cash-based incentives. Once you’ve it sorted, don’t forget the next important step – equity management.