Page 379 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 7. Short-Term Incentives 365

Combination Discretionary and Formula Individual Awards (I). This is similar to “H,”
except the formula allocations are less than 100 percent of the fund (e.g., 90 percent), there-
by allowing the remaining portion (e.g., 10 percent of the fund) to be used to increase some
awards and/or to give awards to some not in the formula plan.
Combination Formula and Discretionary Funded Plans

Discretionary Individual Awards (J). This is the same as the discretionary individual
award determination/formula funded plan, except a discretionary component has been added
to the fund determination. This discretion could be either positive (increase the amount) or
negative (decrease the amount). Companies would have to have very good reason to increase
the amount, having established a formula. However, negative discretion may be well received
by the shareholders. For example, management may have decided that for whatever reason
(e.g., unforeseen good news for company and/or bad news for competitors), financial per-
formance reflects something of a windfall, and therefore discretion is applied to bring the
fund back to a more appropriate amount. Even lacking such unforeseen events, the formula
(unless periodically adjusted) will likely continue to generate ever-higher amounts as the
company grows.
Formula Individual Awards (K). This is a formula individual award determination/formula
funded plan with some discretion on the size of the bonus fund or a combination discre-
tionary/formula funded plan with discretionary individual award determination with the
individual’s awards determined by formula, not discretion. This is probably a top-down,
bottom-up, top-down, with the last an allowable adjustment based on a discretionary
adjustment to the total fund.
Combination Discretionary and Formula Individual Awards (L). This is a combination
discretionary/formula funded plan with formula individual award determination with discre-
tion added to individual awards determination or a combination discretionary/formula award
determination formula funded plan with discretion also included in fund determination. It is
the most sophisticated of the combinations, requiring independent judgment both on fund-
ing and individual award determination. Negative discretion could be applied to both the
overall fund and to individual awards.
Other Fund Types

Deductible vs. Nondeductible Fund Formulas. One of the main problems in construct-
ing the formula is generating an appropriate amount. The deductible formula has a thresh-
old or minimum performance level that must be reached before generating fund dollars
(e.g., X percent of net income minus Y percent of common stock equity). The non-
deductible formula (e.g., A% of net income) begins generating a bonus fund with the first
dollar of measured performance. These two formulas are shown in Figure 7-4. Each has a
problem. The nondeductible formula begins accruing dollars for what many may consider
to be poor performance. The deductible formula addresses this issue with its threshold
feature, but the result is a steeper trend line than the nondeductible formula and may there-
fore pay out more than is considered appropriate for outstanding performance.
Furthermore, this formula is likely to be quickly outdated because factors in the formulas
often move faster than the number and base earnings of the bonus candidates. When the
formula generates more than is allocated, a decision must be made (assuming the plan