Page 377 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 7. Short-Term Incentives 363

Formula Individual Awards (E). Although this approach may include a guideline fund
determined at the outset, it is more likely established after the sum of the individual awards
has been calculated. The discretionary calculation could be used to reduce the total awards,
but since they are formula driven, it is more likely they would be increased because of a belief
in the hard work and effort expended. This is similar to a “B” plan with a discretionary
overview on the total to be paid.
The individual formula could be a percentage of the discretionary fund, a stated dollar
amount, or some combination of the two. Another variation is to give the individual the
percentage of the fund that was equal to his or her annual pay in relation to the company
payroll.
Combination Discretionary and Formula Individual Awards (F). This is very similar to a
“C” combination with the discretionary funding decision made at either the outset or after the
individual awards have been summed to determine if the total is appropriate. A negative discre-
tion formula, used by some to comply with tax requirements, would be an example. The indi-
vidual formula sets the maximum, which is then reduced by discretion of the compensation
committee to comply with Section 162(m) of the IRC (described in Chapter 4) to an amount
deemed appropriate. That law states the company is barred from taking more than a $1 mil-
lion tax deduction for any of the named executives in the proxy unless it is a performance-
based plan approved by shareholders. Since such plans may not permit any positive discretion
in determining pay amounts, it opened the door for negative discretion formulas. Many look
like the shareholder protection formulas that will be described later.

Formula Funded Plans
Discretionary Individual Awards (G). The formula for determining fund size is typically
a percentage of profits and is usually found in smaller companies. Discretionary determina-
tion of each individual’s performance is made and summed. If the total exceeds the fund avail-
able, the awards are adjusted downward. An example of this is shown in Table 7-16. In this
situation, a total of $950,000 is available for discretionary awards.

Bonus Fund:
100% first $100,000 (and 50% of remainder) of 60% pretax income
Example:
Pretax income $3,000,000
$3,000,000 60% $1,800,000
$1,800,000 $100,000 $1,700,000
$1,700,000 50% $ 850,000
Fund $850,000 $100,000 $ 950,000

Table 7-16. Formula funded discretionary award example

Formula Individual Awards (H). This is clearly the most quantitative of the 12 possibili-
ties. A formula is used to determine the available fund, and the fund is allocated by formula
to the participants. Possible formulas include the same dollar amount for everyone (unlikely
for an executive plan); a percentage equal to each person’s percentage of total salaries of all