Page 42 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

28 The Complete Guide to Executive Compensation

As compared with company plans, however, divisional incentive plans suffer a great dis-
advantage. Only rarely is a common stock traded on the market for a subsidiary; by financial
definition there is no common stock for a division. But one could set up a phantom stock plan
for a division and a common stock plan for a wholly owned subsidiary if its stock is publicly
traded.
Even a true profit is often difficult to ascertain for a division or subsidiary (due to deci-
sions made by corporate, not divisional, management on cross-divisional pricing, assigned
products, and assessments). Thus, the range of design possibilities for long-term divisional
incentives is severely limited—often so greatly that a corporate plan is the de facto decision.
Determination of market phase is also an important frame of reference for viewing the
importance of each of the compensation elements as shown in the matrix on Table 1-13.

Emphasis by Market Stage
Compensation
Element Threshold Growth Maturity Decline

Salary Low Moderate High High
Employee benefits Low Moderate Moderate High

Perquisites Low Low Moderate High
Short-term incentives Low Moderate High Moderate

Long-term incentives High High Moderate Low
Table 1-13. Compensation element vs. market stage

Threshold
As Table 1-13 shows, the most important element in the threshold phase is the long-term
incentive, essentially for two reasons. First, the need to reinvest earnings for marketing and
production requirements places a heavy curtailment on direct cash outlays. Second, the
potential for the company’s stock prices to rise as it enters the growth phase should help it
retain its top people. The latter is a strong case for the use of stock options.
Start-ups may literally begin in a garage or basement. When the product or service is
considered viable, the individuals seek and receive backing from venture capitalists and from
attorneys. As key contributors are selectively added, they may receive stock or stock options
due to the scarcity of cash. As staff expands and money is more readily available from finan-
cial backers, cash compensation for selected executives is more available. However, equity
participation is still the dominant form of compensation. New hires and ongoing employees
both receive grants considerably larger than employees in growth stages. Equity awards, typ-
ically in stock options, are allocated on the basis of percentage of company or percentage of
available pool.
The promise of probable future success shifts the attention from venture capital to an
initial public offering. One or two years before this is likely to occur, the organization focus-
es on putting in place formal policies based on competitive analysis. This would include more
formalized stock option grant guidelines, namely, eligibility, size, frequency, and vesting.