Building an executive compensation package

Your organization's executive compensation package is essential to attracting and retaining the upper-level management responsible for guiding the company – the C-suite executives, company officers, and key operational, legal and financial personnel whose collective efforts ultimately determine your success. It's important to realize that modern executive compensation isn't just about salary: it's a suite of items that includes retirement plans, deferred compensation, severance protection, stock awards, benefits like health insurance, and more. This article can help you better understand:

• Why executive compensation packages are important.

• Key elements of a competitive package.

• Federal regulations and executive compensation guidelines to take into account.

Why are executive compensation packages important?

First of all, executive compensation packages play an essential role attracting and retaining top talent. Consider:

Highly skilled professionals at the top of their game are coveted by companies — and they have plenty of options. You have to be an employer of choice in order to stand out enough to attract them. Nor can companies afford to take the people they already have for granted: with employee tenure dropping 11% in the past ten years, finding ways to retain talent is increasingly important.

Robust executive compensation packages — which include a competitive fixed salary along with other attractive benefits — can help organizations create more compelling offers to prospective hires, then keep those executives on board longer. Just as importantly, variable compensation such as stock awards or bonuses can be structured in a way that aligns individual performance with the growth of the company as a whole. When executives are appropriately motivated and invested in the organization's short-term and long-term performance, positive outcomes are much more likely to happen.

Components of an executive compensation package

The detailed elements of a competitive executive compensation plan can vary greatly depending on the company, industry, and, to some degree, the state of the employment market. Having said that, consider including some or all of the following components:

Base salary

An executive’s base salary defines how much they’re guaranteed to earn annually without the addition of bonuses or other financial payments. While this is one of the most critical parts of a compensation package, most executives will also look at other benefits and incentives when making job decisions.

Benefits

Executive benefit plans can play an important role in job offer acceptance, and include the following:

• Health insurance: Considerations include available plan packages, percentage of premiums covered, and cost of premiums for additional dependents. Executives may receive more competitive health insurance that offers additional benefits, such as covering fertility treatments or having lower deductibles.

• Life insurance: Options may include whole life insurance, term life insurance, permanent life insurance, or universal life insurance. These life insurance policies are purchased by key employees, who then own the policy, dictate the beneficiaries, and manage the funds within the policy. Key person life insurance also provides protection for businesses if key employee becomes disabled or dies, which can be used to recruit and train a replacement, pay off debts, or cover lost revenue.

• Disability insurance: Disability insurance plans offer financial protection if the policyholder cannot work due to covered illness or injury.

• Supplemental retirement plans: In addition to the qualified plans that all employees receive, employers can provide a supplemental executive retirement plan for key employees. These plans pay out additional retirement income which may exceed the caps imposed by qualified plans.

• Severance protection: When employees sign an agreement, which may include non-disclosure agreements or an acknowledgment they won't sue, they receive a guaranteed severance package when they leave that may include salary continuation, unemployment benefits, insurance benefits, and more.

• Non-qualified deferred compensation: Executives can choose to delay receiving a portion of their earned income to a later date, which often is around their expected retirement date. A deferred compensation plan allows the income taxes to be deferred until the income is paid out, typically in retirement. While it does not replace pensions, it can be particularly helpful for key employees working for employers who don't have pension plans.

Short term incentives

Bonuses and performance pay are the two most common types of short-term incentives included in executive compensation packages.

Some executive compensation packages may guarantee a percentage of a company's annual revenue growth as an executive bonus, for example. Others may offer performance-based bonuses if a certain amount of revenue is generated or certain business objectives are accomplished.

Long term incentives

Executive compensation packages may include long-term incentives to help key employees buy into the company's long-term success. They may include the following:

• Stock options: Allows employees the right to buy a certain number of company stock shares.

• Restricted stock options: Gives executives the option to buy a set number of company stock shares at a fixed price.

• Performance stock: Gives employees a share of the company's success if performance goals are met; they're specifically tied to performance goals and don't have strike prices that employees need to pay.

Different stock options may have tax implications, including a capital gains tax if selling stock, so key executives should consult with financial professionals.

Federal regulations and guidelines for executive compensation

There are federal regulations and guidelines that organizations need to consider when creating executive compensation packages, starting with disclosure laws. The Securities and Exchange Commission (SEC) oversees federal security laws that require clear and understandable disclosure regarding compensation for the chief executive and other key employees in public companies. This information becomes publicly accessible, which means employers can use publicly available data from their competitors to inform their own compensation offers to potentially sway new talent.

It’s important to remember that shareholders can become involved in the process under the SEC rules, which include the following:

• Say-on-pay: Shareholders can vote on whether or not they approve of the current executive pay package.

• Pay ratio disclosure: Public companies need to release the median compensation of employees at the company, total CEO compensation, and the ratio between CEO compensation and median employee compensation. This may impact shareholder perception of pay packages.

• Pay-for-performance disclosure: Public companies must disclose the relationship between executive compensation and company performance.

Some states may also have local laws around executive compensation and disclosure, and it’s crucial to ensure you’re compliant with both federal and state laws. So it’s important to engage relevant legal, tax and HR professionals who can help guide you through the process of crafting a compelling executive compensation strategy.