Changes to executive pay packages during the COVID-19 pandemic have been swift, revealing stark differences in how boards approach compensation for public and privately held companies. Many executives at public companies reliant on annual and long-term incentives (LTIs) are facing significant pay cuts in the wake of dwindling profits with more economic uncertainty ahead. For stable or growing privately held companies, this presents a buying opportunity to attract and capitalize on executive talent with the right compensation strategy.
Executive Pay Practices
Media coverage based on filings and disclosures required for public companies along with say on pay votes ensures most people are familiar with executive pay practices at public companies. This publicity and the large role played by proxy advisors has resulted in a standardization of executive compensation in public companies as no one seems to want to stand out. To play it safe, public companies typically target the market median with stock performance the largest component of pay results.
Private companies, on the other hand, without the limitations of public exposure can implement more creative pay programs that are crafted to each organization’s unique circumstances. With stock performance a non-factor, other innovative measures including non-financial metrics can play a more meaningful role.
Although pay practices for both public and private companies vary significantly depending upon the industry and type of ownership, all are designed to attract and retain top-notch talent. For private companies, this means making pay sufficient for the quality of executive they are seeking and aligned with the values and goals the organization has established.
However, in our current, challenging business climate, private companies have the distinct advantage of being more flexible, agile, and inclusive than their publicly traded counterparts. In that sense, it may be a golden opportunity to seek where the grass may be greener to upgrade or expand executive ranks.
The Elements of Executive Pay
Public company executive compensation is comprised of three components: base salary, annual or short-term incentives (STIs) and long-term incentives (LTIs). In public companies, incentives dominate executive pay, including annual incentives and long-term, equity-based incentives. Further, in public companies LTIs are the largest component of compensation.
In contrast, private company pay centers on cash compensation, emphasizing base salary and annual incentives. Cash pay is often positioned above the market median, with low or no LTI opportunity. However, this trend is changing as more private companies offer more incentive-based compensation as reported in the Compensation Advisory Board (CAP) and WorldatWork 2019 survey of Incentive Pay Practices.
Executive Pay Components
|Base Salary||Annual or Short-Term Incentives||Long-Term Incentives|
|Public Companies||1) 20% of compensation package|
2) Some are temporarily reducing base salaries
|1) Financial incentives tied to key performance metrics|
2) Sustainable Impact measures: Environmental, social and governance
3) Seeing reductions of 25% to 50% of the current plan target opportunity
|1) Some adjusting targets on a year-by-year approach|
2) Others extending the performance period
|Private Companies||1) Stressed|
2) One-third to half of compensation
|1) Financial measures: profitability and revenue |
2) Individual performance common
3) Threshold payment about 50%; maximum payout is 150% to 200% of target opportunity
|1) 60% offer LTIs|
2) Cash-based plans most common
3) Phantom stock, or real stock vehicles added by minority of companies
Add LTIs to the Pay Mix
Long-term incentives are fast becoming a growing element of executive compensation for private companies. They are essential to attract talent in competition with public companies where LTIs are common. In addition, LTIs play a major role in company retention strategies and to motivate executives to achieve long-term objectives.
For owners at private companies, they must thoughtfully consider if and how they are willing to share ownership in the enterprise with other executives. In addition, they should consider succession plans and future liquidation or merger opportunities depending on their long-term plans for the business.
A typical sharing percentage range is between 5% -10%. Phantom stock is another vehicle often used, although these programs require sophisticated valuing studies and strong communications support. A final option is a long-term cash plan. This requires solid financial planning and transparency of key financials.
Benchmark for Success
Executive pay has come under increased scrutiny in the current business climate. New attitudes about work and pay practices are being shaped by the pandemic, as well as social and cultural trends in an election year like no other. Executives seeking to make meaningful contributions may find even greater opportunity at private companies embracing innovative strategies and pay practices. Private companies recruiting new talent can cast a wider net and utilize benchmarks for non-traditional sources and their market competitors.
Still, benchmarking in a rapidly changing business environment can be challenging, making salary projections more obscure. Regardless, the quality of survey data obtained for an executive search must meet high standards. Survey sources should be carefully examined to ensure data cuts are available based on industry and size, which are closely related to the level of executive compensation.
With less public scrutiny and fewer regulatory hurdles, private companies have more freedom to make proposed changes in creative ways that balance stakeholder interests, improve employee morale and boost the bottom line. Executives at public companies may be ready for a change if an opportunity promises a promotion or broader role or one with more autonomy and more responsibility.
Yes, pay will certainly be an important piece of the equation. However, at a time when job losses in the top ranks may be considerable, enterprising private companies should view this as a recruiting opportunity to build on for the future.
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