Executive pay is very different from other compensation practices you administer, involving greater pay-mix complexity, more components, and consideration of various business and legal factors. Here are executive compensation basics that you need to know to drive your business results as well as attract and retain key executive talent.
Create an executive compensation philosophy
Establishing and communicating a formal compensation philosophy for executives is an important part of an executive compensation program. This philosophy should clearly explain the principles on which executive compensation decisions are based and how executive pay programs are driving the organization's needs and strategic goals (Lupo, 2010). Comprehensive documentation of rationale supporting your organization's executive compensation programs is also an important part of your program. Additionally, this philosophy may define who qualifies for executive compensation (typically only the highest paid executives).
Invest time in executive compensation program design
Executive compensation should start with your business's goals and objectives. Define what the strategic objectives of the business are, how the company will define success in 3-5 years, the kind of talent needed to support its business strategy, and how long you want to retain the talent. This strategy will help your organization make decisions on the other elements of executive compensation design including pay mix, performance measures, and pay position relative to the market (Hosken & Laddin, 2011).
Additionally, identify taxes, governmental regulations, and industry trends that affect executives' compensation. All of these issues should play a role in how and what you decide to pay your leaders.
Gather executive compensation market data
Many organizations use market data to establish executive compensation. Choose surveys that are similar in revenue size and industry and whose participants reflect your peer group. Peer groups may be those companies similar in revenue, market, number of employees, or performance. Peer groups could also be companies that you compete with in your industry or for executive talent.
In addition to salary surveys, ERI is a strong data source to use for executive compensation decisions and contains specialized industry data. ERI's data meets expert witness reliability standards and is cited in Sarbanes-Oxley proxy disclosures as a data source used to determine executive compensation. Plus, ERI is relied upon by many private corporations smaller in size. You can also compare your positions to data from the most relevant or comparable public firms using proxy statements.
If your organization is a small to medium sized private company, however, be cautious when comparing your executives' compensation, benefits, and perquisites to only readily available information about public company executives. Only a small percentage of U.S. companies are public and these figures are usually much larger than what executives actually earn at similarly sized organizations (Chief Executive, 2011). For example, in one of our latest surveys, a CEO's median base salary was reported at $203,000 and median bonus was reported at $63,200, which are far lower than figures for much larger public organizations.
Benchmark types of executive compensation pay
Typically five types of pay should be benchmarked to obtain a true picture of how executives should be paid. These include base salary, short-term incentives, long-term incentives, perquisites, and benefits. As a result, a solid survey or source of compensation data should include at least the following information: base salaries, bonuses, total compensation, benefits, and perquisites. Most organizations that we serve use bonuses (tied to organizational profitability/performance and individual performance) and base salaries for executive compensation.
When analyzing pay, revenue is usually the most common factor used to determine executive compensation because executive pay is directly related to size and revenue of an organization. Using industry can also be helpful, but look first at the revenue breakout. If the survey is smaller in scope, be sure to look at broader industry definitions for the most reliable results. These breakouts will tend to have more data.
Anticipate executive salary increases
Currently, executive salary increases and adjustments have been projected lower than past years. Traditionally, executive increases hovered around 4%, however, most surveys - including those conducted by Mercer, WorldatWork, and ERC show that executives can expect increases of around 3% in 2012. These projected increases, however, are slightly higher than the 2.8-2.9% increases seen since 2009, but do vary according to the position.
Keep in mind that making pay decisions (such as increases) for executives involves considering how those decisions will impact your organization's costs down the road. A 4% increase for an executive translates to a much larger cost than a 4% increase for a factory employee.
These are just some of the basics of executive compensation that you can use to help determine how and what to pay your leaders. Keep in mind that managing executive pay can be very complicated, depending on your business, objectives, needs and peer group, so be sure to seek expertise in this area or credible market data on executive compensation practices to help you make good business decisions.
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- Hosken, E. & Laddin, D. (2011). Best Practices for Executive Compensation. WorldatWork Workspan.
- Lupo, P. (2010). Top 10 Considerations for Establishing an Executive Compensation Philosophy. Pearl Meyer & Partners.
- ChiefExecutive.net (2011). Media Wrong About CEO Compensation.