Page 21 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 1. Executive Compensation Framework 7

The most common perquisites are a company car, financial planning (both capital
accumulation and tax minimization) and supplemental executive retirement plans (SERPs).
The latter are of two types: restoration (replacing benefits curtailed by Section 415 of the
Internal Revenue Code and therefore sometimes called Section 415 plans) and add-ons
(which typically supplement short service for second-career executives).
Short-Term Incentives
Short-term incentives (Chapter 7) are designed to include both downside risk and upside
potential, rewarding the extent of accomplishment of a short (normally, yearly) target.
Typically, the amount of payment goes up and down each year in relation to performance,
thereby lowering costs to the organization when performance is low while providing the exec-
utive an opportunity to attain significant rewards for achieving or exceeding objectives. An
example of the degree of risk identified in the salary element above is shown in Figure 1-3.
The more darkly shaded area represents the short-term incentive opportunity. As risk increas-
es, salary (the lighter shaded area) decreases, but it is more than proportionately replaced by
incentive opportunities.

Competitive
Pay Level

No Low Moderate High
Risk Risk Risk Risk
Figure 1-3. Risk/reward relationship to market data

Objectives may be group or individual in nature and should be tied to annual business
targets in a way that provides clear line of sight (i.e., one should not have to look around
corners in an attempt to see the connection). Financial results are typically major compo-
nents of short-term plans. Incentive pay increases as a percentage of salary as salary increas-
es, thereby providing ascending reward opportunities. Some identify this as the progressivity
principle.
Short-term incentive plans range from highly individualistic rewards for individual
accomplishments to sophisticated profit-sharing plans that emphasise corporate, group, or
division performance with little variation for individual recognition. The main drawback of
the latter type is that they will overpay the marginal performer in good years and underpay
the outstanding performer in the poor years.
Common financial measurements used in short-term plans include economic profit
(after-tax operating income minus the cost of capital), earnings per share (net income divided