Page 576 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

562 The Complete Guide to Executive Compensation

It is important to remember that the design of the short- and long-term incentive
plans should be appropriate not only at the beginning of the measurement period but
also when paid out—a fact not considered by most designers and approvers of pay plans.
For this reason, it is not inappropriate for both to be reconsidering design modifications
on an ongoing basis.
2. Is it understood that the incentive plan will have to be reviewed annually in terms
of appropriateness to industry, company, management, tax, accounting, and
Securities and Exchange Commission (SEC) issues? Unfortunately, the view of
almost everyone is that after sweating through the installation of a new pay program,
they can forget about it for at least several years. The result is that, after such a time span,
the plan requires major surgery and continuity is significantly jolted.
Fund formulas should be reviewed periodically. Old and outdated formulas will
typically provide greater funds than required because they were established when
earnings were lower. One test of efficacy is ascertaining whether the same amount of
discipline is exerted as when the formula was last modified. A related question is
whether the budgeted targets have similar stretch to earlier goals.
Conversely, financial performance will be more positive under historical-cost account-
ing than if those figures were adjusted for inflation and present-day cost of replacing
assets. Therefore, formula-based historical-cost accounting to generate short- or long-
term incentive payouts should be examined very carefully before being modified.
Parenthetically, it should be noted that while most plans can deal with the results
associated with FIFO (first in, first out), LIFO (last in, first out), and NIFO (next in, first
out), no one has been able to develop a meaningful incentive plan when FISH is
employed (i.e., first in, still here).
3. What impact does a change in top management have on the executive compensa-
tion program? Regardless of whether the individuals came from within the company or
from the outside market, this is a logical time to review the compensation plans. Even if
there are no changes in strategies, it is important to review with the new executives the
plan design and structure to ensure they understand how it will relate to their perform-
ance. If the person(s) came from outside the organization, chances are high that a new
focus on company mission and at least strategies will follow, requiring a reworking of the
executive pay plans.
4. Do the executives understand the pay plans and how they relate to their own
performance? A review of the executive pay program should be conducted at the time a
person is promoted into a new executive-pay-eligible position. This discussion some-
times leads to consideration of plan modifications based on executive input.
5. How does one minimize having a new pay plan manipulated? The design of a new or
modified executive pay plan is tested against desired outcome, preferably by being on a test
basis for a year (perhaps in parallel with the old plan) to determine what changes have to
be made. But it is also helpful for a savvy executive, perhaps the former CEO, to indicate
what inappropriate action the plan may encourage to receive payment. This is similar to
having a former sales representative expose the flaws of a new sales incentive plan.
6. Should reviews be undertaken when the business press focuses on a particular
form of executive pay? The answer is, of course, yes. Typically, the business press
focuses on the negative aspects of a practice, such as backdating stock options or permit-
ting personal use of corporate jets. This should automatically result in a review of own
practice to determine whether it is still appropriate. An ongoing thorough review of pay