Page 412 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

398 The Complete Guide to Executive Compensation

Recognition Awards. Cash or noncash award for acknowledging a specific outcome or
event, may be for short or sustained period of time. Typically not part of executive incentives.

APPROVAL OF PAYMENTS

If a fund formula is used, it is typical to have the chief financial officer and the audit commit-
tee attest to the amount generated. The same would be true for financial performance targets
(e.g., ROA). The compensation committee of the board of directors might take responsibility
to approve the sum of all proposed awards (within an authorized fund if there is one) or simply
the awards for the CEO and other executives named in the proxy, delegating responsibility for
other payments to the CEO and his or her subordinates.

BENEFIT PLAN IMPACT

Over the years, more and more companies have included annual incentive payments as com-
pensation for many benefit plans. The most significant is for pension plans. Most surveys
show that a majority of companies will include annual incentives in pension plan calculations,
both defined benefit and defined contribution. Less popular is their inclusion in survivor
benefit and other plans

SUMMARY AND CONCLUSIONS

Short-term incentives are an expense and therefore a charge to the company’s income state-
ment for the period in which earned. They are also tax deductible to the company and tax-
able as income to the executive. Proxy treatment is equally simple: they are reported for the
year in which they were earned.
Although all companies provide salary and benefits (and possibly some perquisites), not
all provide short-term incentive opportunities. By definition, results have to be measurable
within a short period (e.g., one year). It cannot be assumed that simply because a company
produces an annual earnings statement it needs a variable compensation plan tied to the
results. The annual model cycle in an industry (e.g., automobiles) is a classic situation argu-
ing for an annual incentive plan. However, to the extent eligibility goes beyond those
making the decisions affecting results, the plan shifts to a profit-sharing plan.
To be cost effective, performance must be commensurate with incentive. By definition,
overpaying those whose performance has slipped narrows the pay difference between barely
acceptable and outstanding performance. Unfortunately, some managers expect the bonus
system to automatically preclude this from happening. They have confused the ends with the
means. The incentive plan is merely a pay-delivery system; it has no native intelligence.
Certainly, it is unrealistic to assume that in developing an incentive plan, all possible conditions
can be examined and factored into the formula.
To the extent the incentive plan correlates positively with performance, it will be possible
to retain aggressive, results-oriented individuals—as well as attract new ones to the company.
These are people who are more concerned with self-actualization and ego reinforcement than
security. The mere existence of an incentive plan will not assure their presence; it is, however,
the payoff that will determine their interest in remaining with the company.