Executive Compensation

What Is Executive Compensation?

Executive compensation refers to the payment made by the company to senior executives in the form of salaries, benefits, and bonuses. The primary purpose of this compensation is to motivate and incentivize senior management to remain with the organization. It is also referred to as executive pay.

This pay is usually for the chief executive officer (CEO), chief finance officer (CFO), and other executives. Hence, executive compensation packages are designed to attract, retain, and motivate talented leaders while aligning their interests with those of the company's shareholders.

• Executive compensation refers to the clubbed payment package provided to the senior executives of the management. It includes the CEO, CFO, board of directors, and other top leaders. 
• The origin of the concept dates back to 1936 in the United States. However, the substantial prevalence and spread occurred in the 1970s. 
• There are three major types: short-term, medium-term, and long-term compensation. Thus, the main components are salary, benefits, bonuses, stock options, and performance shares. 
• However, such executives may sometimes hire a consultant to negotiate the terms. It helps during severance and layoff periods.

Executive Compensation Explained

Executive compensation is a popular concept of corporate governance curated for senior management. It is a kind of compensation made to the top executives for their work. So, if a company has a better package for the board members, they will perform vigorously. The origin of the executive compensation plan dates back to 1936 in the United States. Executive pay is a crucial factor that drives the company's performance. In addition, the business strategies are also influenced similarly. It typically consists of a combination of salary, bonuses, stock options, and other benefits.

The process of executive pay works akin to employee compensation, yet it differs. The format for documenting the salary and benefits of senior employees is different. It is a customized and separate contract. Since they hold extreme knowledge and skills, the pay cannot be discussed, unlike other employees. Furthermore, executive compensation analysis is crucial for promoting transparency, accountability, and fairness in corporate governance.

There are different types of executive compensation plans available for the executives on each level. It includes short-term, medium-term, and long-term compensations. Short-term pay includes immediate benefits like paid expenses or bonuses. However, the medium-term compensation depends on the company's performance. So, if the firm performs well, more benefits will be delivered to the senior executives. In contrast, the long-term pay includes stock options or performance shares. But this compensation is only visible in the long term as the value of the stock is subject to time.

Companies opting for executive pay must consider specific points. For instance, firms must report any changes in the executive compensation plan in the Form 8-K suggested by the Securities and Exchange Commission (SEC).

Components

Different types of executive compensation elements constitute the body. Let us look at them:

1. Salaries: Also known as base salary, it is a fixed payment made to all employees. The duration of payment can be either monthly or annually, depending on the contract. However, some factors like work experience, skills, and knowledge may also influence the salary amount.
2. Bonuses: As a part of the short-term pay, bonuses are a vital component of encouraging executives. They act as a reward for the work performed but in the short term. So, if the contribution of the CEO and CFO leads to multiple revenues, the company and executive compensation consultant may give bonuses as an incentive to them.
3. Perquisites: The term perquisites refers to the special advantages or benefits offered to the executives. Some of them include club memberships, easy access to events, private jets, and many more. However, such incentives are offered by a few executive pay consultants.
4. Stock options: Many firms listed on the exchange often provide stock options to staff. It means that the executives can buy equity shares at a pre-set price within a certain period. As a result, they can access the stocks before other investors.
5. Performance shares: With the name itself, these performance shares are only available to a few employees. They are only provided when executives reach a particular milestone or success. It serves as a special reward or token for their extra efforts. However, one unit of performance shares (PSU) is equal to one common stock.
6. Benefits: In addition to the above elements, various other benefits can be offered in executive compensation packages. These include insurance plans, vacation time, paid leaves (or paid time off), and others.

Examples

Let us look at some examples of executive compensation to understand the concept better:

Example #1

Suppose a technology firm "Husslte" appoints John Kenny as the new CEO of the company after the exit of Mr. George. Before his appointment, Kenny had already worked as a board member of other firms. Additionally, he has relevant experience at the top management level. As a result, the technology firm decided to hire him as the chief executive officer. Later, the management decided to keep the salary at $620,500. Also, there were additional benefits offered to John.

After a year, the company saw a drastic change in its strategies. The business was expanded in many fields, and the revenue multiplied. Therefore, the firm decided to give ten performance shares to Kenny for this milestone.

Example #2

According to the latest news, as of November 2023, the food service provider Bid Corporation Limited has announced a new executive compensation package. The chief executive officer of Bid, Bernard Berson, will receive a package of R20.6 million ($1.06835 million). This pay structure is calculated after considering the industry average. However, in comparison to other peers, Bid is paying the CEO a higher salary. Besides, Berson also owns around R231m shares in the company.

How To Negotiate?

After considering the following types, executives can still negotiate with the executive compensation data provided. It may help them get a better deal. Let us look at some tips:

#1 - Considering The Entire Package And Not Just The Salary

At the corporate level, salary plays a vital role in the pay structure. However, at some points, the salary offered may be less than usual. As a result, employees can still negotiate with the firm to raise the bar. But, if they cannot fulfill the requirements, there can be hidden benefits also. Thus, the foremost tip suggested to executives is to recheck the entire package before rejecting it. But, in some cases, the firm may offer a comparatively low salary, but there might be other exclusive benefits.

#2 - Extending The Excise Options

Executives can demand to include an extended excise option in their contracts. It typically increases the time after exiting the company. So, if the CFO leaves the company, they can still exercise their rights in the later stages. However, the period is restricted from 90 days to 1 year or more.

#3 - Involvement In Milestone Payments

Additionally, the executives can also negotiate the compensation terms to include milestone payments. It ensures that the employee gets paid according to performance for a consistent flow.

#4 - Severance Times

Given the number of layoffs occurring, it is safe to include severance terms. It protects executives from a financial perspective. Three to six months' severance time is reasonable. However, the terms must be clear and precise to avoid any payment issues.

#5 - Hiring An Executive Compensation Consultant

At times, it might be challenging to negotiate the terms of executive pay. In such cases, it is best to hire an executive compensation consultant or advisory firm. They focus on designing and creating packages curated for senior leadership positions.

Importance

Apart from the negotiation, executive pay also plays a vital role in the corporate world. Some of them are discussed below:

• The executive compensation reflects the success of the company. If the package offered is good, it means that the firm is making good revenues to cover the costs of compensation.
• It incentivizes executives to contribute more to the firm's success; however, a lower package may discourage them.
• Likewise, the compensation of other employees is also connected to the executive compensation provided. If the latter acts in the best interest of the executives, the latter will work harder to achieve the desired goals. Hence, this will result in better business strategies and revenues, and the employees will also receive an upward increment in their salaries.
• Furthermore, it also provides a defined direction for the company's objectives to achieve them in a shorter time. They also boost the existing company performance and growth metrics.

Frequently Asked Questions (FAQs)

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