Page 22 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

8 The Complete Guide to Executive Compensation

by total number of shares outstanding), return on assets (net income divided by total assets),
return on equity (net income divided by shareholder equity) and cash flow (the change in
amount of cash for the period).
Representative nonfinancial measurements are customer satisfaction (using question-
naires and interviews), new products (percentage of sales or income represented by products
introduced in the last year or two), productivity (measured in terms of cost, quantity, and
quality), and workplace issues (e.g., diversity, work/life balance, and image).
Payments are typically in cash, although some plans pay a combination of cash and shares
of stock.
Long-Term Incentives
This element (Chapter 8) is similar to short-term incentives in objective, except the perform-
ance period is multiyear in nature (typically 3 to 10 years). Normally, there is no individual
performance component in long-term incentives, only some definition of group. The incen-
tive award (which is typically significantly larger than the annual incentive) by definition
means the executive has a portion of pay placed “at risk” with degree of attainment of busi-
ness objectives. Not meeting the expected target calls for no payment or a low payment—a
form of punishment short of termination of employment. The multiyear nature of long-term
incentives provides some holding power over the executive if the payout will be significant
later on. The progressivity principle defined in short-term incentives also applies here. Pay
is typically based on shareholder value or the financial performance of the defined unit (e.g.,
company, sector, or division), or both.
Some argue that there are midterm plans (e.g., two to five years, such as restricted stock
and performance share or unit plans) as well as long-term plans (e.g., more than five years, such
as stock options). Most will simply state that anything multiyear in nature is a long-term plan.
The forms of long-term incentives are expressed in terms of those dependent on stock
price and those independent of market value stock price. The multiyear nature of these plans
creates a problem in predicting performance years in the future. The difficulty of setting such
targets is a function of the degree of cyclical fluctuations within the particular industry. In some
plans action is needed to adjust individual payments; in all plans it is a requirement for setting
future targets—even the stock option grant requires some assumptions about future value.
Form of payment follows the type of plan. All market value stock plans are typically paid
in shares of stock. All other plans are cash plans and are typically paid in cash (and in some
instances shares of stock).

Relative Importance of the Elements
As depicted in Figure 1-2, but perhaps more clearly in Table 1-4, these elements of compen-
sation take on different emphases at different pay levels in the organization.
For example, salary might be 75 percent of total compensation at the $100,000 level
but only 20 percent at the $5 million level. Conversely, long-term incentives might only be
2 percent at $100,000 total pay but 50 percent at the $5 million level. Table 1-5 converts
these percentages to dollars. Thus, at the $500,000 total-pay level, the 40 percent salary
shown in Table 1-4 reflects $200,000 as reported in Table 1-5.
At higher levels of total compensation, decreasing emphasis is applied to salary and
benefits, whereas an increasing emphasis is given to short-term incentives, long-term incen-
tives, and perquisites. The reason for the decreasing emphasis on salary at the expense of