Realigning Executive Benefits With Objectives
By: David King
All companies know they must provide meaningful incentives to attract and retain talented executives with the experience and vision to move their businesses forward. At the same time, the corporate scandals of the past few years have motivated investors and regulators to seek assurance that company leaders are not placing their own interests ahead of those of the firms they lead. Business owners and board compensation committees across North America are responding to these concerns as well as scrutiny from the media by taking a hard look at how their firms compensate senior executives.
Company stakeholders have found a voice in recent legislation aimed at strengthening corporate governance such as the U.S. Sarbanes-Oxley Act of 2002 and the Canadian Investor Confidence Rules. Among the far-reaching effects of these regulations is their role as a primary catalyst for executive compensation reform.
Strong Push For Disclosure
Transparency is the watchword of senior management benefits reform. Never has public scrutiny of these programs been greater and the call been stronger for full disclosure. In designing compensation packages, companies are attempting to better balance the perception of these benefits with their retention value and a growing consideration is how they will explain these programs to a variety of constituencies.
The objective is to create a reward system that will appeal to high level managers, yet incorporate sufficient transparency to earn the confidence of all stakeholders – from investors to employees and customers. Following are some of the elements of typical executive benefits programs and how they are changing:
In wide use during the dot-com boom of the 1990s, stock options have come under attack in the past few years. Reasons include the role of the market’s turn-of-thecentury decline in pushing options underwater and fears of share-price dilution. The future of stock options is also clouded by efforts to require public companies to include their cost on income statements as an expense. In the United States, the Financial Accounting Standards Board’s push for this accounting change is moving forward, though it continues to face strong industry resistance. This proposal would also affect the more than 500 SEC-registered companies operating in Canada.
There is no question that broad-based employee stock option programs aid recruitment efforts, particularly those of companies in the high-tech sector and smaller organizations seeking a leg-up in the competition for talent. But at the executive level, businesses want to avoid public perception of options as providing financial windfalls to a few individuals and, at the same time, address the desire of top managers to have more security in their personal financial planning. In addition, companies need equity incentives designed without the conflict of interest that was common in past arrangements.
As a result, firms are embracing a number of alternatives to traditional stock options. Recent choices include:
- Restricted stock where shares are linked to a vesting period and then worth whatever the stock is currently valued at, making them less risky than options
- Performance shares that are paid out only if certain performance targets are met
- Stock appreciation rights which pay executives, either in stock or cash, the increase in a stock’s value between the time a grant is made and when it is exercised
Non-qualified compensation and benefit deferral plans
Previously overshadowed by the appeal of stock options, non-qualified compensation plans are increasing in popularity. These arrangements allow executives to defer a part of their current income until a specified future date.
At the same time, they allow a company more flexibility. While qualified plans such as retirement savings plans also allow deferred compensation, non-qualified plans for upperlevel managers have few limits. Among the different plans:
- Voluntary deferred compensation (VDC) plans – Companies can use these plans to reward key contributors without the cost and complexity of qualified plans that must be offered to all employees. They often appeal to executives since they allow them to avoid taxable limits on contributions and benefits.
- Supplemental executive retirement plans (SERPs) – These plans can include such features as pre-retirement death benefits and post-retirement income and allow the employer to set qualifying criteria. As pension benefits diminish, SERPs offer top employees more predictability in planning their retirement portfolios.
- Deferral plans – These can be very attractive to executives and are powerful retention tools for the company, but they are not without their disadvantages. If a business declares bankruptcy, for example, plan participants may receive nothing. In addition, plans must stand up to the higher standards and increased scrutiny created by corporate governance reforms. Legislation such as the new Canadian Investor Confidence Rules, for example, could limit the flexibility of these plans and the outcome should be closely watched.
Supplemental insurance benefits
Companies often provide their executives with extra healthcare and other insurance benefits beyond what the typical employee receives. This may include supplemental long-term disability, life, and medical insurance. Top managers are sometimes offered annual physicals or certain other preventive health screenings at the company’s expense.
For years, companies have offered executives a variety of non-cash benefits and privileges or ‘perks.’ Not easily categorizable, executive perks can include country club memberships, company cars (sometimes with drivers included), first-class air travel, access to airport VIP lounges, special dining facilities, and even every day services such as dry cleaning. A few other examples that are being offered by companies include:
- Reserved parking spaces
- Health club memberships
- Credit cards with special features
- Paid spouse air travel
- Use of company aircraft
- Financial planning services
- Special relocation allowances
As the economy shifts up or down, executive perks are likely to follow in the same direction. But it is not the economy alone that tends to influence these rewards, or at least the kinds of rewards companies offer.
Image Of Excess
Much of the shareholder and employee concern over executive compensation has been focused on perks and the image of excess they often convey. In an improving economy, the problem for businesses that wish to issue them is, therefore, less one of cost than of perception. As companies attempt to improve governance and make their accounting activities more transparent, compensation committees are making moves to ensure that the perks they do offer will not embarrass the firm or attract undue attention when disclosed.
As a governance issue, executive compensation is not likely to escape scrutiny any time soon, if ever. Companies that regularly re-evaluate their top-level benefits programs to ensure they are attractive, yet straightforward and easily understood will be in a much better position to satisfy internal and external constituencies alike.
David King is the central/ southern Ontario regional vice-president of Robert Half Management Resources (www.roberthalfmr.com).
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