Page 26 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

12 The Complete Guide to Executive Compensation

Unlike for-profits that incur a loss, there are companies that are formed deliberately to
not show a profit in order to receive favorable tax treatment; they must meet the require-
ments specified in the Internal Revenue Code to qualify. Although nonprofits do not intend
to make money, they will get a lot of attention from the IRS if they show a significant residue
left after paying all their expenses. Lacking a profit incentive removes many of the incentive
opportunities (both short and long term) available to the for-profits.
Subject to some exceptions, executives in nonprofits are exempt from personal liability,
with creditors entitled only to assets of the corporation. The inability to issue stock or pay
dividends limits the choices available in executive pay planning to heavy use of benefits and
perquisites.
Privately Held vs. Publicly Held Companies
Publicly traded companies are those that are required by the Securities Exchange Act of 1934
to register their issues because of an offering to the public, as described in the Securities Act
of 1933. A company not meeting these requirements is considered to be a private (or private-
ly held) company. Where much of the stock is in the hands of a few, it is considered to be a
closely held, private company. The best example of a closely held private company is the sole
proprietorship, in which the company is owned by one person. This form is common for small
companies and rare for large organizations. Because the individual and the company are the
same, the profits are taxed to the owner as personal income. When two or more individuals
form a business and agree to be personally liable for the debts of the business and share
in the profits the business is a general partnership. When limits are set on the role of the
partners and their liability for the debts of the business, the business is a limited partnership.
Subchapter S (Section 1361 of the Internal Revenue Code) is a version of a small,
privately held company. Here the stockholders are taxed on the company’s earnings propor-
tionate to the percentage of stock they own. This avoids the double taxation of dividends of
other corporations.
Another type of closely held company is the limited liability company (LLC), which is a
combination corporation-partnership. LLC members are taxed like members of partner-
ships, with income subject to income, Medicare, and social security taxes. However, unlike in
a partnership, personal assets are not at risk when the LLC is deemed liable.
Being privately held is sometimes so attractive that a large shareholder of a publicly trad-
ed company proposes to take the company private by buying out the stock held by others.
Since the individual wishes to do so at the lowest possible cost, such plans frequently result
in law-suits by other shareholders wanting a better price for their stock.
Two other versions of privately held companies are co-ops and mutual organizations.
A co-op is a company owned by its customers or suppliers, such as one selling agricultural
products. A mutual is another example of an organization owned by its customers, such as one
selling life insurance.
One might expect privately held companies to pay higher salaries than their public coun-
terparts due to the absence of publicly traded stock and capital gains opportunities. However,
this is far from a general rule—the reverse may even be true. Short-term incentives for both
are very comparable using both internal and external measurements, although privately held
companies may use less of the latter. Long-term incentives are similar in design, but the
absence of a public stock market restricts the attractiveness of equity issues in private
companies. Owners not wishing to diffuse ownership are another reason for limited use.
Shares are typically subject to a buyback requirement stipulating that they must be offered