Executive compensation

Scope

An executive’s salary may be determined by a combination of several factors including years of experience, sustained level of performance, size of company, industry peer group, and must often receive board or committee approval.

Regulatory citations

• None

Key definitions

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Summary of requirements

Employee benefits. The typical employee benefits which an employer provides to its employees also makes up a portion of an executive’s total pay package. This would include time off with pay, health and dental insurance, short-term and long-term disability coverage, life insurance, and retirement plans (i.e., a defined contribution plan or a defined benefit plan). However, there are often additional employee benefits given to executives which may include additional executive life, disability insurance coverage (usually at a level higher than the average employee), retirement plans (see Supplemental Pension Plan), and deferred compensation arrangements (see Deferred Compensation).

Awards/bonuses. Bonuses and other awards are often determined by the performance goals in place and whether or not they are met. Incentive plans can take many forms, the most common being:

• Short-term bonus (usually a one-year time frame)— often the greatest individual motivator.
• Long-term bonus (more than one year — usually 3 to 10 years) — created to afford “holding power” over executives for a longer period; usually based on group performance goals.
• Stock options — rights to purchase company stock at a specified price during a specified time period; usually considered a long-term incentive.
• Restricted stock — stock is given to the executive who must wait for a specified period (usually 3-5 years) before selling it. Stock will be forfeited if termination occurs prior to the end of the restriction period.
• Stock Appreciation Rights (SAR) — the right to receive a dollar amount equal to the future appreciation of the company stock (rather than actual shares).

Supplemental pension plan. For a select group of management or highly compensated employees, an unqualified pension plan or a Supplemental Employee Retirement Plan (SERP) may be offered in addition to the qualified plan. The compensation limits are not governed by the maximum Internal Revenue Service (IRS) limitations as under a qualified plan. Therefore, the employee can take advantage of the unlimited benefits earned under this plan. There are no tax benefits associates with this type of nonqualified plan.

Deferred compensation. Deferred compensation may include a qualified plan such as a 401(k) plan, or it can also take the form of a nonqualified deferred compensation (NQDC) plan. This is any elective or non-elective plan, agreement, method, or arrangement between an employer and an employee (or service recipient and service provider) to pay the employee compensation some time in the future. These plans can include voluntary deferral of earned income, mandatory deferrals of bonuses, as well as other types of retirement plan vehicles. NQDC plans do not afford employers and employees with the tax benefits associated with qualified plans because, unlike qualified plans, NQDC plans do not satisfy all of the requirements of Section 401(a).

Fringe benefits (perquisites or “perks”). Corporate executives often receive extraordinary fringe benefits that are not provided to other corporate employees. Any property or service that an executive receives in lieu of or in addition to regular taxable wages is a fringe benefit that may also be taxable income. These types of benefits begin where the usual employee benefits leave off and are usually not performance based.

The following lists some of the most common fringes provided to executives.

• Athletic skyboxes/cultural entertainment suites,
• Club memberships (i.e., country club),
• Corporate credit card,
• Executive dining room privileges,
• Loans,
• Outplacement services,
• Security-related transportation,
• Spousal/dependent life insurance,
• Transportation (company automobile),
• Chauffeurs,
• Employer-paid parking,
• Relocation expenses,
• Non-commercial air travel (company jet),
• Employer-paid vacations,
• Spousal or dependent travel,
• Wealth management (financial planning),
• Retirement planning services, and
• Employee’s share of FICA taxes paid by employer.

Severance package. Most executives of larger companies insist upon a written employment contract at hire which will include a severance package (often called a “golden handcuff”), and is usually prepared or approved by an attorney. The amount of severance pay (often referred to as a “golden parachute”) varies and may include several months of pay, or several years of pay in some situations, upon termination of employment or a change in control. Because of the potential loss of future income, severance pay benefits are highly important to executives. The terms of the employment agreement should be specified in the contract.

Increased scrutiny. There has been much in the news regarding CEO and executive pay. It continues to come under increased scrutiny by shareholders, board of director groups, the Internal Revenue Service (IRS), as well as by employees of the company.

In addition, the latest scandals involving stock option backdating have caused attention to be focused on the unethical ways that executives are receiving these special benefits. The Pension Protection Act of 2006 (PPA) has just begun to scratch the surface, and will no doubt keep executive compensation on the radar screen of the public going forward.

Dodd-Frank Act. The Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted on July 21, 2010, contains numerous provisions affecting executive pay. One section of the Act addressed shareholder voting rights regarding executive compensation and golden parachute agreements (severance and benefits paid upon termination of employment or a change in control).

Provisions include the following:

• Vote on Executive Pay and Golden Parachutes: Gives shareholders a say on pay with the right to a non-binding vote on executive pay and golden parachutes. This gives shareholders a powerful opportunity to hold accountable executives of the companies they own, and a chance to disapprove where they see the kind of misguided incentive schemes that threatened individual companies and in turn the broader economy.
• Nominating Directors: Gives the Securities and Exchange Commission (SEC) authority to grant shareholders proxy access to nominate directors. These requirements can help shift management’s focus from short-term profits to long-term growth and stability.
• Independent Compensation Committees: Standards for listing on an exchange will require that compensation committees include only independent directors and have authority to hire compensation consultants in order to strengthen their independence from the executives they are rewarding or punishing.
• No Compensation for Lies: Requires that public companies set policies to take back executive compensation if it was based on inaccurate financial statements that don’t comply with accounting standards.
• SEC Review: Directs the SEC to clarify disclosures relating to compensation, including requiring companies to provide charts that compare their executive compensation with stock performance over a five-year period.
• Enhanced Compensation Oversight for Financial Industry: Requires Federal financial regulators to issue and enforce joint compensation rules specifically applicable to financial institutions with a Federal regulator.

Rulemaking. On October 18, 2010, the SEC issued proposed rules enabling shareholders to cast advisory votes (nonbinding) on executive compensation and golden parachute arrangements. Following a request for public comments, the final rule appeared in the Federal Register on February 2, 2011.

Public companies subject to the federal proxy rules must now provide shareholders with a vote on executive compensation (say-on-pay).

Shareholders must:

• Vote on executive pay at least once every three years (may be every year, every other year, or once every three years) beginning with the first annual meeting held on or after January 21, 2011;
• Vote on the desired frequency of say-on-pay votes at least once every six years; and
• Receive additional information and be given an advisory vote in connection with golden parachutes in merger transactions.

Small companies were given a temporary exemption until January 21, 2013, to conduct say-on-pay and frequency votes.