If Rip Van Winkle Awoke Today – Part 2: Executive Pay Plans and Long-Term Incentives

If Rip Van Winkle Awoke Today – Part 3: Executive Pay Plans and Long-Term Incentives

We are periodically looking at changes that have occurred in our practice areas over the last two decades to commemorate our 20th year in business. Last month we talked about sales management. Let’s shift gears a bit today and talk about the subject of executive pay plans and long-term incentives.

Executive pay has always been a specialized and separate reward tool available to Boards of Directors and ownership. It has been an area whose practices, regulations and objectives have created challenges quite different from those experienced in any other field of compensation design or management. Of course, when I speak of executive compensation I really refer to long-term incentives for the executive—because in reality, executive salaries and short-term (annual) incentives generally differ from those of other employees only in terms of scale. We believe two words best describe what we have seen happening to long-term executive incentives since 1989. These words are: SHIFT and MORE.

  1. Shift—
    • There has been a general shift in Focus (and most likely in dollars) from other types of classic compensation tools (salary and annual incentive) at the executive level to long-term incentives.
    • There has been a shift in eligibility – from only a small cadre of positions at the top of the house to a larger group of executive/management positions within the company. However, in no way are these rewards being offered to any employees except those contributors determined to be most important to future success. A contradiction to this, however, is the widespread use of stock options within some public companies. Yet this practice may represent more of a benefit than a form of executive compensation and pay for performance.
    • There has also been a shift to longer-term payout horizons to stress the importance of key employee retention. Where we once saw many three-year plans and payout tables, I now see (and recommend) increased use of arrangements that pay out between five and ten years into the future, within IRS guidelines.
  2. More
    • There is more interest (and a greater prevalence) in long-term incentive tools being used in private and family companies today. In 1989, long-term incentives were the province of the public company—with a few exceptions. Today, private company owners and Boards have become enthusiastic users.
    • There is more science utilized in measuring and evaluating long-term incentives. In today’s environment there are demands to know what a “share” is worth, what the value of a payout will be 10 years into the future and precisely what factors will drive both reward and future valuation. Terms like, cost of capital, variability, liquidity discount, Black-Scholes Model and binomial distribution have now routinely entered discussions in the Board room. The quantification of this field of executive pay is clearly evident when we see the present value of executive long-term incentive awards now reported in major annual executive pay surveys—for all levels of executive.
    • There is much more involvement by the Board of Directors in any and all executive compensation decisions. Where a Board once delegated most pay decisions to the CEO and management team, it is now integral to the decision process itself—how much, who, why, when. In fact, many Boards now retain their own executive compensation counsel for advice and guidance. This was rare ten years ago. We now consider this to be a best practice for public and larger-private companies. Wilkening & Company provides this kind of service.

Does your company use long-term incentives? Have you experienced these or other changes? (See our background discussion regarding long-term incentives in the September edition of E-Notes available on our website).

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