Page 249 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 6. Employee Benefits and Perquisites 235

The employment contract is most prevalent in smaller organizations, although larger
companies have used them to obtain key executives or retain an executive (after a successful
acquisition or merger). They have also become very common for CEOs and other key
executives. There is no tax effectiveness rating in a contract per se, and its component parts
are taxed in the manner they would normally be taxed. The value to the executive is con-
tinued employment for a prescribed period of time and a very clear understanding of the
compensation to be received; the value to the company is that it has increased its probability
of retaining a key executive (especially if the contract includes a noncompete clause and
protection of confidential information if the executive leaves). Even those not covered by an
extensive employment contract may be required to sign a confidentiality agreement at
the time of hire or along with a significant change in responsibilities. The content of the
agreement may vary from one unit to another within the company; however, typically it
would require the executive not to disclose any confidential information to those outside the
company without explicit permission.
The employment contract should also define how much severance pay (if any) is added
on to the unworked, paid period of the contract. An employment contract is of very high
importance to those taking on new responsibilities and/or a new employer. Without such
protection, executives and employees must rely on the company’s severance pay policy.
However, the terms of severance pay will likely include prorated incentive payments and
vested stock option grants.

Severance Pay
Performance and Organizational Restructuring. The employee who does not perform
satisfactorily or who is no longer needed may receive another form of pay for time not
worked—severance pay. Conceptually, severance pay is intended to bridge the period of unem-
ployment, and supplements unemployment compensation provided by state and federal
governments. Initially, the state benefits were not subject to income taxes; however, they are
no longer completely excludable. Section 85 of the Internal Revenue Code (IRC) limits the
amount that may be excluded. This amount is sufficiently low that most executives will pay
tax on unemployment benefits if they have any other income that year, since benefits are
added to any other gross income during the year.
Many years ago, it was not uncommon for the boss to tell a worker on Friday afternoon,
“You’re fired! Don’t come to work on Monday.” In lieu of advance notice, the company might
give two weeks’ pay. Over the years, trade unions negotiated an additional week per year of
service, thereby making a distinction between short- and long-service employees.
The 1987 Worker Adjustment and Retraining Notification (WARN) Act addressed the
issue of prior notice. It required employers with 100 or more workers to give at least 60 days’
advance notice of a plant closing or mass layoff. During the two-month period between noti-
fication and effective date, the individual was to be paid (and assumedly would work).
Enlightened companies use the same schedule for individual actions as well. Companies are
usually lenient during the notification period, especially with executives, in allowing time off
for job searches. Additionally, the amended Age Discrimination in Employment Act (ADEA)
of 1967 prohibits termination based solely on age if over age 40.
A typical company severance plan for all employees might be two weeks’ pay plus two
weeks for every year of service. Therefore, an individual with 12 years’ service would receive
26 weeks, or about six months’ pay. Some companies distinguish between individual and