In addition to compensation planning for employees, organizations must also focus on executive compensation planning for business leaders. With the right executive compensation plan in place, organizations can attract and retain top talent with the necessary experience and motive to push the company forward.
What is Executive Compensation?
Executive compensation refers to pay, pay incentives, and benefits packages exclusively for executives and managers in public businesses. Executive compensation typically includes base salary, short-term and long-term incentives, severance pay, and perks, which I’ll discuss more in detail below. Founders, presidents, and chief financial officers are examples of who can qualify for executive compensation.
Although executive compensation is essential for many businesses, it’s not void of challenges. Perhaps most significant is that organizational needs and setbacks influence executive compensation. For instance, a rough year for revenue could affect the benefits packages or incentives an executive usually would receive. As such, executive compensation remains somewhat fluid, sometimes resulting in pay cuts during tumultuous business periods.
Stocking a compensation committee—the group of people responsible for the research, planning, and development of executive compensation for an organization—with reliable and knowledgeable people can also be a challenge. The committee typically consists of board members who get voted into their positions, so having a fair and equal voting strategy is key to creating the right committee.
Additionally, laws and regulations governing executive compensation exist, and organizations must keep themselves updated on any changes to ensure compliance. I’ll dig into these regulations later in this guide.
What’s in an Executive Compensation Package
An executive compensation package typically includes the following pay components.
First and foremost, executive compensation packages include the base salary of each position aside from any bonuses, commissions, or extra pay perks. Most executives receive an annual salary rather than an hourly wage.
Base salary is usually a small fraction of the total compensation package at large organizations, which often include retirement plans, investment structures, unlimited paid time off, and more. These are also included in an executive compensation package, but separate from base salary. It’s important to highlight base salary on its own in an executive compensation package to ensure pay equity across similar positions and experience levels.
According to Indeed, the average executive salary in the United States is $98,085, but pay can vary significantly by location and exact role. Other Indeed data shows that executives tend to make anywhere from about $55,000 to $315,000 or more.
Short-term incentives offer executives bonus pay in addition to their base salary. These incentives are designed to pay executives when they reach short-term business goals with a deadline of one year or less.
Short-term incentives can help get executives aligned with their organization’s short-term goals by providing additional pay when those goals are reached. Some companies evaluate and adjust goals quarterly, semi-annually, or annually and pay out short-term incentives after evaluating those goals and executive performance.
A few examples of short-term incentives that might be defined in an executive compensation plan include:
- Annual objective bonuses: These bonuses are awarded to executives who meet specific company objectives at the end of a calendar year, fiscal year, or company objective plan.
- Profit-sharing plans: Profit-sharing plans let executives share the company’s profits that result from meeting specific goals.
- Team bonuses: Team bonuses pay shares to everyone involved on a team working on a specific project or toward a specific goal after meeting the project or goal objectives.
- Discretionary bonuses: Discretionary bonuses can be given to an executive at any time for any reason, usually for meeting a goal or going above and beyond their usual responsibilities.
Short-term incentives are designed to offer quick gratification, which can be excellent for in-the-moment rewarding.
In contrast to short-term incentives, long-term incentives pay out their rewards over time. However, executives can begin earning these incentives currently. As an example, stock options and restricted stock units (RSUs) are long-term incentives. Executives may begin earning them after being with a company for a year, but their benefits won’t necessarily pay out until the future.
Long-term incentives in an executive compensation plan are helpful for recruiting and maintaining top talent. Many long-term incentives provide employees with part ownership of the company, which can increase loyalty. In the case of RSUs, executives may be required to stay with the company for a length of time or give up their stock if they choose to resign earlier
A retirement plan is another example of a long-term incentive. This highly prized benefit encourages longevity from employees, as staying with a company that provides contribution matching can help them increase their retirement savings over time.
Executive positions tend to include several perks that stretch beyond long-term and short-term incentives and bonuses. These benefits can improve morale and employee satisfaction while optimizing recruitment efforts. Although these aren’t always monetary benefits, they are still cast in the net of executive compensation and should therefore be included in a compensation plan.
For instance, a company might furnish laptops and other equipment to executives to help them set up their offices. Or, they pay for a company vehicle or mobile phone for executives to use for work purposes. These perks become part of the compensation plan. Other perks for executives might include:
- Health insurance
- Supplemental life insurance
- Paid time off
- Flexible schedules
- Remote work
- In-house child care
- Travel reimbursement
- Paid training or education
- Flexible work arrangements
- Corporate discounts
- Relocation stipends
- Conference stipends
- Free tax services
- Student loan assistance
- Tuition reimbursement
- Stipends for professional attire
- Free meals
- Employee health and wellness programs
Severance pay is the money a company pays an employee who ends their employment with the company. Usually, it’s granted when a company downsizes or lays off employees, but some executives may also receive severance pay when they retire.
Severance pay is not currently regulated by law. However, the Employee Benefits Security Administration, a division of the U.S. Department of Labor, can help employees receive the severance pay benefits to which they are entitled based on their employer-employee contract. That means it’s up to companies to provide severance packages that they follow through with.
Some companies provide what’s known as golden parachute severance packages. These hefty packages usually contain loads of benefits, including ongoing pensions, stock options, health insurance, or special bonuses. Although they can be enticing to executives, they may also reward low-performing executives with coveted benefits they haven’t necessarily earned.
Fairer benefits to place in a severance package can include payment for unused paid time off, job search assistance, uncontested unemployment benefits, and transferring company-paid phones or laptops to employees.
Some companies also choose to add language in a severance package to protect company interests. For example, confidentiality agreements can help ensure that an employee doesn’t share protected information about the company with others. Also, a non-compete clause prevents an employee from working with a competitor for a specific length of time after leaving the company.
These are optional clauses to add to your severance package. However, if they are included, they should have clear and transparent language, and executives should be made aware of them before accepting their positions.
SEC Regulations for Executive Compensation Plans
The U.S. Securities and Exchange Commission (SEC) oversees the process of public companies disclosing executive compensation information to the public. Specifically, the SEC requires companies to offer clear and transparent information about how much its executives get paid and the company’s finances. Usually, this information is provided in a company’s annual proxy statement.
Other places the public can view this information include:
- The company’s annual Form 10-K
- The company’s most current Form 8-K
- The company’s securities for sale registration statements
Although the SEC requires this information to be publicly available for public companies, the agency doesn’t regulate how or how much an organization pays its executives.
Other federal agencies also have laws regarding employee compensation. For example, the Internal Revenue Service requires reporting of all executive compensation, while the U.S. Department of the Treasury restricts aspects of executive compensation for recipients of the Troubled Assets Relief Program (TARP), which was enacted in response to the economic crisis of 2008.
Executive compensation regulations can change over time based on the current economy, labor laws, and corporation regulations. Organizations must do their due diligence in keeping current with evolving laws to ensure compliance.