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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.

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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.

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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.

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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.

Summary

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.

Contact Us

For help or information on this topic, you can email me at nlappley@lappley.com or call (847) 921-2812.

When we look back, 2020 will long be remembered as a year of massive change for business and industry on a scale not seen before.

The COVID-19 pandemic has plunged our economy into a global recession and put health and wellness at the center of workplace conversations. Worldwide protests supporting the #BlackLivesMatter movement have joined #MeToo voices urging meaningful community action on discrimination, pay equity, and inclusion.

In response, organizations are making significant changes to their business models and accelerating the adoption of Environmental, Social and Governess (ESG) criteria to guide business investment and decision-making. They recognize that their organizations’ stakeholders are motivated by more than a goal for increased revenues and profits; other success metrics include environmental, social responsibility, gender, and racial diversity measures to track progress on social and economic purpose. Some are calling this new integrated approach to corporate governance stakeholder capitalism.

In tandem with these changes, proactive CEOs and HR professionals are taking a step back to reassess their compensation programs, so they align with a more purpose-driven business model. This is an opportunity to transform massive challenges into meaningful change, but it will require a thoughtful and strategic compensation approach that looks at the following:

1) Assess critical job skills. Quite likely, as the result of an updated business model, critical skill jobs have changed. They should be identified and monitored for pay competitiveness. These employees are most susceptible to being recruited away.

For instance, purchasing professionals are dealing with disruptions in their supply chains, especially in manufacturing. Sourcing from India and China has become problematic during the pandemic. Employees that can fill supply chain gaps are highly valued and in great demand. Employers may need to prioritize their investments in these job skills even when resources are scarce.

2) Revisit your compensation strategy. This flows from the company’s purpose and business strategy and is part of the organization’s overall HR strategy. To the extent that your business model has changed, compensation strategy must also follow the organization’s purpose or why it exists. A recent Compensation Alert here takes you through the elements of establishing your strategy. A critical part of your updated strategy will be to reestablish your benchmark of competitive and comparable organizations, update your current competitiveness levels and determine your targeted level of competitiveness.

3) Take a fresh look at pay equity. Many employers have implemented pay equity analyses to identify whether they have gender or race-based compensation gaps. They have done this to promote fairness, retain talent, and mitigate risk. If you have not done a pay equity analysis already, you should begin the effort soon. If you have, dig deep into the data to determine what is driving pay disparity: the actions of certain managers or decision-makers; out-of-date policies or business practices; or unconscious biases within a division or department. You can learn more about Pay Equity and The Rules of Engagement here.

4) Review base salary and incentive plans. Many companies have taken salary actions in the wake of the COVID-19 health crisis. These include pay cuts, cancelled salary increases or freezes, delayed or deferred annual salary increases, and adjusted planned average salary increases. In addition, organizations have suspended promotional increases or added additional pay for essential work (often called hazard or hero pay), while others have reduced or suspended benefit programs. As the economy improves, business leaders must determine when and under what conditions salary actions taken during the health crisis will be lifted or withdrawn.

It is too early to forecast levels of average merit increases for 2021. It is more likely, however, that more companies will not be giving salary increases next year. Even more, this will vary by industry and region, so it is prudent to develop a good idea of what your competitors will be targeting.

Incentive plans have also taken a hit from the pandemic, as organizations have modified their short-term and annual incentive programs by reducing opportunity, deferring or delaying payments, and adjusting performance targets. Changes to long-term plans have been less prevalent. Consider the following actions:

  • Short-term plans: As you plan for the second half of the year and revenue and profit expectations crystalize, consider: increasing the use of management discretion in determining 2020 incentive/bonuses; changing performance measures consistent with repurposing of the company; and lowering performance targets, maximums and thresholds. Additionally, revisit base payouts on second half performance against second half goals.
  • Long-term plans: Take no actions for the next several months. Consider adjusting performance targets if goals become unattainable.

5) Do not overlook your sales force. The COVID-19 pandemic had a great effect on sales organizations. Orders for commercial and industrial goods were curtailed. Falling orders meant less revenue for sellers for sales compensation credit. Our work with clients indicates that most companies have implemented pay protection methods to replace some or all lost sales incentives for sellers. The most popular methods include pay guarantees, quota reductions and formula changes.

It is time to reset for the balance of the year. Sellers need to be reengaged to reactivate suspended opportunities and find new revenue. A good time to start fresh is July 1st, the start of the last half of the fiscal year for many organizations. But at the same time, discontinue pay protection programs. The sooner you are beyond pay protection programs the better. Consider the following actions to fast-track sales revenue:

  1. Redo quotas: Continued uncertainty will make it difficult to project expected revenue for the second half of the year. However, take into account new avenues for revenue based on your adapted business model as well as revenue purchasing customer patterns. Develop stretch goals.
  2. Review payout formulas: Thresholds, incentive rates, accelerators and caps should be reviewed.
  3. Jump start incentives: As an add on, use a combination of contests and spiffs to add excitement, and motivation. Provide both cash and non-cash awards. Keep the jump start short – a maximum of three months.

In Conclusion

Uncertainty and change will be the hallmarks for organizations during the remainder of 2020 and into 2021. Short of a crystal ball, prudent planning to address the workplace issues of our time is your best bet to make your culture stronger and better equipped for future growth.

Despite current economic hardships, visionary business leaders who understand where and how to prioritize investments in talent will seize the opportunity to recruit the best and the brightest for the road ahead.

Contact Us

To discuss how to adjust your organization’s compensation strategy and develop more meaningful benchmarks and metrics to make your workplace stronger, please contact Neil Lappley at (847) 921-2812 or nlappley@lappleiy.com.

Late last year, Congress passed and President Trump signed into law the Tax Cuts and Jobs Act (TCJA). The sweeping tax reform law reduces the marginal corporate tax rate at the federal level from 35 percent to 21 percent. This and other changes to tax law are boosting profits and will save businesses billions in taxes this year. So, how are they spending all that money?

Most companies are reinvesting their tax savings in strategic ways that drive business performance. So far, shareholders are reaping the greatest rewards, according to an analysis by investor Paul Tudor Jones’ Just Capital. Job creation is the second largest area for investment with 20 percent allocated. Jones’ nonprofit is tracking spending by companies in the Russell 1000; 133 companies have announced their intentions to date.

In addition, a recent Ernst & Young (EY) survey finds most employers are either planning to or have already made changes to enhance compensation through bonuses, salary increases and other pay benefits. Seventy three percent of companies surveyed expect to accelerate mergers and acquisitions.

Considering these and other trends, now is a good time to revisit your business compensation strategy to take advantage of opportunities that effect employee pay. Before making any long-term decisions, however, let your company’s business goals be your guide so that tax savings are invested where they will do the most good.

Making Tax Reform Pay

Tax cuts have contributed to growing optimism about the U.S. business outlook. And that optimism has translated into a strong economy.

Still, companies must be nimble to adapt to changes in the new tax law. Making the right strategic moves on where to invest tax savings requires thoughtful planning. Here are a few areas to consider:

1. Equal Pay – As more people keep a close eye on the pay gap, employers everywhere are working to eliminate wage discrimination based on sex, race, age, disability and other classes protected by federal laws. In this environment, they are evaluating how they can structure their compensation system so that it works for all employees. This means developing policies and compensation strategies that reward people performing well in the same jobs with similar work experiences, skills and education equally.

Yet, implementing changes means choosing a structure that pays internal employees fairly and is competitive externally. Consider using a portion of the tax break to identify any anomalies in your compensation structure. Then, develop solutions to pay disparity that can be implemented in phases over a reasonable time-period, as budget allows.

2. Shareholder Return – Shareholders who have invested in your organization expect a fair return. You can pass along tax savings to shareholders with an increase in dividends. This can take the form of a one-time payment or an increase in the quarterly rate. Another option: share buybacks.

3. Business Expansion – Companies who want to expand geographically, diversify product offerings or tap into new customers may choose to invest their tax savings in a merger or acquisition. With M&As, compensation programs must also be merged. Make sure your compensation strategy includes these important elements:

  • Competitive Pay Analysis – As the market for top talent gets tighter, attracting and retaining employees gets more challenging. This may be a good time to revisit the competitiveness goal defined in your organization’s overall compensation strategy. Consider using the tax reduction to fill in pay gaps. Look at national, regional and local market trends. Increases may be either to the entire organization or to select segments where compensation has increased faster than overall market wages.
  • Base Salary – The annual salary measures ongoing job worth and ongoing job performance. Under the TCJA, the performance-based compensation exception to executives $1 million pay cap has been eliminated. Now, compensation for the CEO, CFO and the three other highest paid executives is capped at $1 million regardless of whether compensation is performance-based or not.
  • Annual Incentives or Bonus Plans – These reward executives for reaching annual milestones or other incentivized, short-term financial goals. Cash is still the dominate incentive for private companies. Be sure to set goals for profitability or revenue growth as key performance measures. In January hundreds of companies announced employee bonuses resulting from the tax reform law. Although the pace of these announcements has slowed, more and more companies are following the national bonus pay trend.
  • Long-Term Incentives – This incentive rewards executives who create long-term value, a win-win for all when strategic objectives are met. You will also want to specify the length of the performance period, eligibility requirements, incentive opportunities, performance measures, and the payout or holdback schedule.

Whether your business is small and closely held or ranks in the Fortune 500, the new tax law will have wide-ranging implications for your compensation plans in 2018 and beyond. Please contact me at (847) 921-2812 or nlappley@lappley.com if you would like to discuss further. Also, feel free to share this article with anyone who might be interested.