Page 252 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

238 The Complete Guide to Executive Compensation

the location of a few skeletons. A cynic would argue these are all forms of conscience
money; the pragmatist would indicate that any severance pay formula merely quantifies the
agreed-to values for determining the amount of pay. The reason for a formula is consistency
in application. The formula should adequately compensate for past service contributions
without overly penalizing failure to perform.
Since severance pay is somewhat analogous to alimony, some argue for companies to
make regular payments (not a lump sum that could be rapidly squandered). However, regular
payments could serve as a disincentive for the individual to seek other job opportunities.
Some argue that payments should not cease when a new job is found, for such an approach
only encourages the employee to “cheat on the company.” It is better, they say, to consider
the remainder a bonus for getting the new job faster than anticipated. Others more logically
argue that severance payments are transition awards until new employment is gained. Even
when lump-sum payments are used, it may be advantageous to the individual whose employ-
ment is terminated later in the year to have a significant portion of the payment deferred to
the subsequent year for tax purposes. Such arrangements must be carefully orchestrated to
avoid constructive receipt issues.
Executives are terminated for failures in performance and/or the inability to mesh with
decision makers. As a matter of fact, the less-than-competent executive may keep the job if
he or she is well liked by those responsible for making the termination decision, whereas a
topflight performer might be terminated for making waves (and being seen as a personal
challenge to the authority of others). Thus, in spite of many of the teachings of results-
oriented management, what matters in some organizations is not how well one performs but
the extent to which one’s personality is compatible with others. Nonetheless, consistent
failure to meet short-term objectives and/or long-term goals will lead to termination.
Termination for poor performance requires the individual be aware of the performance
problem and be given an opportunity to correct it before the termination action. A company
that uses its bonus plans to acknowledge performance can communicate to an executive very
clearly about poor performance simply by cutting back or eliminating the bonus. In such
companies, it would be unlikely that a person would have back-to-back zero-bonus years and
still be around. In companies with modest variation in compensation adjustments, there is
greater need for a face-to-face discussion with the executive about performance improve-
ment. This is unlikely to happen since it is this same inability to deal with problem cases that
causes modest compensation adjustments! This situation usually deteriorates until manage-
ment finally fires the person, or convinces him or her to retire if that is a reasonable option.
Because of the potential loss of future income, severance pay benefits are of high impor-
tance to executives. It is always nice to know there is a good safety net. While severance pay
is offered after termination due to ineffective performance of duties, it is not usually offered
for terminations due to violation of company rules (e.g., gambling or drinking on the job) or
insubordination. Additionally, committing an illegal act would be considered termination
“for cause,” providing no severance benefits.
The 2004 American Jobs Creation Act added Section 409A to the IRC governing
deferred compensation arrangements, including separation pay. Such arrangements are not
subject to the code if (1) there is no legally binding right to the separation pay, (2) it is a
short-term deferral (namely, payment in full occurs within two and one-half months of
close of the business year), or (3) there is a substantial risk of forfeiture. There are also three
safe harbors that exempt being subject to the code. They are as follows: (1) collectively
bargained separation pay arrangement; (2) payment cannot be more than two times the