Question

Pay Packages Explained

Executive pay packages differ substantially from typical salaried or hourly employee compensation because unlike typical employee pay, the vast majority of an executive's pay is contingent compensation and structured only to reward the executive for actual, positive company performance and growth in shareholder value. To this end, executive compensation packages typically utilize six distinct compensation components:

Base Salary

Short-Term Incentive

Long-Term Incentive

Employee Benefits

Perquisites

Severance/Change-in-Control Payments

A company's Compensation Committee will structure their executive's pay packages utilizing a combination of the above components to help achieve the company's Pay for Performance and/or Retention objectives.

Using this article and the text, work through the following: You are on a BOD and head of the compensation committee. The company sales are flat, profitability in the lower quartile for the industry that is growing at 5% per year. Outside consultants have determined it will take three years to turn the company around. Develop a structure for a compensation program for the CEO and key officers. Define the elements, potential measures and targets for a comp program.

Answer 1

Given:

•        The company sales are flat
•        Profitability in the lower quartile
•        Industry that is growing at 5% per year
•        Three years to turn the company around

•        Executive's pay is contingent compensation and structured only to reward the executive for actual, positive company performance and growth in shareholder value.
•        Six distinct compensation components:
•        Base Salary (Bs)
•        Short-Term Incentive (STI)
•        Long-Term Incentive (LTI)
•        Employee Benefits (EB)
•        Perquisites (P)
•        Severance/Change-in-Control Payments (S/CIQ)

Required:

Develop a structure for a compensation program for the CEO and key officers.

Define the elements, potential measures and targets for a comp program

Solution:

Analysis of data to arrive at compensation program is given below. For simplicity, we have considered only CEO, CFO and CIO positions but can be extended to other executives similarly.

•           The company sales are flat – This indicates the company is not in position to pay a very high compensation to the executives, but at the same time, the industry standard compensation (+/- 10%) must be paid to attract the best talent in the industry. As this component of the compensation is not related to the performance or results, it will be the base salary.

So the Bs = Ic +/- 10%          where C= compensation and Ic-Industry standard compensation ----- (i)

• Profitability in the lower quartile & Three years to turn the company around

Analysis of this situation tells us that the SMART(Specific, Measurable, Achievable, Relevant and Time bound) objective for CXOs will be to turnaround the company in three years – improving profitability by a quartile every year. So if today profitability is in 4^th quartile, in 2ns year it should be in 3^rd quartile, in 3^rd year in 2^nd quartile and in 4^th year it should match the top of the industry standatrd.

Accordingly Long Term Incentive (LTI) will be function of profitaility

LTI = F(P)       where P is profitability, which will be defined for next 3 years. ----------- (ii)

This component will be zero in the first year, as immediate profitability improvement may not be achievable.

• Industry that is growing at 5% per year – This data can be used to determine the short-term incentive (STI). The target for CXO will be to show sales growth of at least 5% year on year. Anything below 5% will not make any STI for the CXOs. So,

STI = F(Sg)     where Sg is sales growth year on year.           ----------------------    (iii)

•           Employee Benefits (EB)                                                                     ------------------           (iv)

            As the organization is not doing well and cant offer high starting compensation, it is advisable to provide following standard employee benefits to the CXOs. The main objectives of these benefits will be to attract and retain CXO level talent and keep them motivated to achieve targets.

            The benefits will be

1.      The best possible office space including corner larger cabins, well-furnished and decorative furniture, state of the art technology tools like laptop, cell phone etc.
2.      Car and driver: the ‘A’ class car with driver – can be used even for non-official travel with fuel and all expenses paid by the company.
3.       Club fees – Club of the CXOs personal choice – annual membership fees will be reimbursed in full by the company.

•           Perquisites (P)            ------------------------------------------------------------------------------------------ (v)

            Similar to employee benefits, following perks will be offered

1.      Fully furnished all-expense paid accommodation with servants.
2.      Unlimited executive class air travel with all expenses paid including travel, food and 1^st class accommodation.
3.       Professional services will be offered by the top-notch consulting companies – for investments, retirement planning and wealth creation.

•           Severance/Change-in-Control Payments (S/CIQ)     ----------------------------------------- (vi)

As per the industry standard, we will offer the modified double trigger to CEO and normal double trigger to other CXOs. This will be equivalent to two to three times the salary and incentive.

So the total compensation package (C) will be :

(C) = (i) + (ii) + (iii) + (iv) + (v) + (vi).