Page 405 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 7. Short-Term Incentives 391

Midpoint vs. Actual Pay. A variation on both of these examples is to use the bonus percent-
age against the midpoint of the range rather than the individual’s actual salary. The former
emphasizes the importance of structure and will result in a greater award for an individual
below midpoint and less for a person above midpoint than using actual salary. Tying bonuses
to the midpoint emphasizes competitive levels of pay; basing the bonus on actual salary
emphasizes the importance of current salary. The latter is an advantage to those better per-
formers who have been in the grade longer and are therefore above the midpoint, but it is a
disadvantage to better performers who are low in range because of brevity of service.
Bonus as a Percentage of CEO’s Award. Another variation on determining the individual
award, particularly at the corporate level, is to do it strictly by a formula set for that year.
Assume there are seven top corporate officers and that the normal compensation relationship
among the seven (based on compensation midpoints) is as shown in Table 7-45.

Compensation Incentive Bonus Basis
Midpoint Ratio
Corporate Group
CEO 100 100% —
President 75 100 —

VP, Group A 60 50 50%
VP, Group B 50 50 50
VP Finance 40 100 —

VP Legal 35 100 —
VP HR 30 100 —
Table 7-45. Incentive compensation vs. midpoints for seven officers

Based on targeted net income of $100 million (an increase of $10 million over the
previous year), a formula is set for the CEO that is expected to generate a $60,000 bonus:
Bonus 0.0002 (net income)
0.004 (net income minus previous year’s net income)

The president’s award would be set equal to 75 percent of the CEO’s (unless there was a
specific reason to make it different). The staff vice presidents would also have percentages
comparable to the pay relationship as shown above unless a specific need for a different
relationship were important. If so, that would be reflected in an adjusted percentage.
The bonuses for the group vice presidents would be determined half by corporate and
half by their own group performance. Thus, the VP of group A would not have 60 percent
of the CEO’s bonus for corporate, but rather 30 percent (i.e., 60 percent 50 percent).
Furthermore, since budgeted income for group A is $70 million (an increase of $5 million
over previous year), the following formula might be appropriate:
Group bonus 0.00015 (group net income)
0.0015 (increase in group net income)