Executive Compensation 101: Trends, Types, and Tips
Compensation for workers at all levels has been rising in response to workforce shortages and other changing economic conditions. In 2022, civilian workers saw their total compensation rise by 5%, with a rise of 4.5% in 2021 (including a 4.9% boost in benefit costs in 2022).* Executive compensation is also rising, continuing its upward trend since the late 1970s. As companies struggle to attract and retain top talent, executive compensation packages have taken center stage in the workforce management discussion.
Look Beyond the Bottom Line to Craft a Competitive Compensation Package
According to Zip Recruiter, the average CEO salary in Michigan is $117,319 compared to the national average of $147,204. CEO salaries in Michigan range from the 25th percentile at $78,606 to the 75th percentile at $171,266. Companies can increase the competitiveness of their offers by crafting customized compensation packages for desirable candidates.
Companies can compensate executives in many ways beyond the base salary. Other forms of valuable compensation include annual and long-term incentive programs, bonuses, stock options, deferred compensation, benefits, and other “perks.” Local, state, and federal tax incentives can also add value to a compensation package without adding cost to the organization.
Crafting the best compensation package starts with the contract, which may be at-will (terminable at any time without notice and for any lawful reason or no reason at all) or guaranteed for a set term. A term contract provides financial security, typically including a severance package if the company ends the employment relationship early and without just cause. Guarantees like severance agreements are another way to “sweeten the pot” for executives without incurring any fixed costs.
Extra vacation/paid time off, flexible work schedules, job sharing, and other perks can be worth much more to an executive than they cost the company. Creative benefit options abound, including relocation benefits, childcare, travel reimbursement, company vehicles, cell phone reimbursement, funding for continuing education, payment of professional licensure fees, country club or luncheon club memberships, fitness studio or gym memberships, conference attendance budgets, student loan payments, reserved parking, and even housing. Some, but not all, of these expenses are deductible for a business.
Thinking Like an Owner: Bonuses, Stock Options, and Deferred Compensation
A bonus incentivizes an executive by giving them a personal stake in the company’s success. A company can designate the benchmark(s) determining when an executive earns each bonus. These can be performance metrics based on the individual’s success or that of their team, tied to the company’s overall increase in value or profits, or set at time intervals to incentivize retention.
Non-discretionary bonuses are payments a company is contractually obligated to pay if certain conditions occur. Discretionary bonuses are payments a company can decide to pay or not without any contractual obligation. Before making an offer that includes a non-discretionary bonus, a company should discuss when it will vest (in the short or long term), how it will be calculated, how it will be paid (stock, cash, or other benefits), and when it will be paid (potentially conditioned on the executive’s continued employment on the date of payment). Bonuses in the form of deferred compensation can also reward executive loyalty and longevity while reducing the present-day cost to the organization.
Rewarding an executive with ownership interests both compensates and gives them more “skin in the game.” There are many different types of stock options, including restricted stock, profit sharing (“phantom stock”), stock purchase plans, and stock appreciation (“golden handcuffs”).
Be Proactive to Avoid Negative Tax Consequences and Legal Issues
Your legal advisory team should review any proposed executive compensation package before making an offer. It is essential to structure deferred compensation packages to ensure they are treated as favorably as possible, as they are subject to Internal Revenue Code Section 409A. Deferred compensation that does not comply with 409A can result in unintended consequences of the employee paying a higher tax on the income.
Along with looking at the legal issues related to a compensation package, your legal team should consider how it fits into your corporate compensation structure. Regular compensation audits help ensure your organization remains equitable and avoids the potential for Title VII litigation. Several states have even mandated transparency of the salary range associated with job postings.
Further, changes to state and federal laws, corporate restructuring, and other operational changes can affect the landscape of your corporate compensation in unexpected and unfavorable ways. Regular check-ins with your legal team can ensure you don’t overlook something crucial that affects existing contracts or fail to anticipate a potential problem.
Join us on March 29, 2023, for the next program in our Breakfast Bites series, Incentive Compensation: How to Structure and Avoid Legal Pitfalls in Compensating Employees from Hourly to Executive. Visit our Events page to learn more and register.
* U.S. Bureau of Labor Statistics, Employment Cost Index Summary; https://www.bls.gov/news.release/eci.nr0.htm