Basics of Compensation and Benefits for Executives and Salespeople

  1. EEOC-Employment Law
  2. Basics of Compensation and Benefits for Executives and Salespeople

Each company has its own unique compensation structure. In large companies this compensation structure will be contained in a salary classification plan which meticulously assigns value to every job within the company. Great care is taken in such plans to ensure that employees who perform the same level of work are paid relatively the same amount of money. By contrast, smaller employers may have no objective compensation plan which results frequently in disproportionate compensation to various employees based on many subjective reasons. The best practice is to have the most rational and objective compensation plan possible for the organization. When possible, employers should have simple, clear, and straightforward compensation plans that make it easy for employers to administer, and employees to understand precisely how they will be compensated. Generally speaking, there are several categories of compensation:

  • Base salary;
  • Short-term incentive payments, also known as bonuses;
  • Long-term incentive payment plans;
  • Executive “perks”; and
  • Other benefits.

Base Salary:

All compensation plans begin with some sort of base pay or base salary. All employees are divided into two simple categories, those who are paid “by the hour” and those that are paid on a salaried basis. A salary is a fixed amount an employee earns per week, month or year. Typically, a salary is communicated by an employer to an employee on an “annualized” basis. The annual number is then divided on a per paycheck, either by-monthly or monthly, depending upon the arrangement of each employer. Salaries are generally paid without regard to how much work the employee performs in a given period. A salary amount or hourly rate is usually the primary building block of any compensation plan. Enhanced benefits and perks are usually driven by total base compensation.

In any given employment relationship, the employee has more bargaining power than they often realize when initially setting their base pay. To maximize this bargaining power, an employee should ask questions during the interview process to determine what kind of process the employer uses to establish the base pay or the base salary amount.

The factors considered by a particular employer to establish a base salary are virtually limitless. Some employers have a very structured formula to determine base salary, and therefore at first-blush do not appear to have much negotiating room. Other employers appear to have no objective basis for establishing base salary and consequently seem to have unlimited negotiating potential. Neither is as true as it would seem. Some factors which contribute to the calculation of base salary are;

  • Experience;
  • Similar compensation in the employer’s professional industry;
  • Personal affiliation or relationship between the employer and the decision maker;
  • The employer’s classification system or structure;
  • Employee’s previous salary history with the company;
  • The expected growth or performance of the company in the future;
  • The discretion of the decision maker, and there are many, many others

When negotiating a base salary, employees should take care during the interview process to determine what the real drivers are for the particular decision maker and/or company, and what factors are being considered when determining base salary. When a company decides to hire an employee, that’s the highest that employee’s “stock” is going to be for quite some time. Job candidates should exploit this advantage when at all possible.

A job candidate should investigate thoroughly the compensation plans and structures at the potential employer’s competitors. It is also helpful to know what kinds of compensation similar jobs are bringing at companies outside of the potential employer’s industry. For example, a candidate to be CFO of a corporation would want to know what other similarly situated CFO’s in the industry are making, but would also want to know what private CPA firms are paying CPA’s with similar experience, as well as, any other potential employers in the employee’s job search. The simple argument, “I can make more money at ______”, can be very effective at this stage.

Candidates should also inquire about how the company sets salaries during the interview process. Does the company have a formal salary classification structure? Is there a compensation committee which sets executive salaries or other salaries? What are the criteria for setting salaries and granting raises? These answers can be quite illuminating both in terms of what the future may hold, but also in what negotiating points there might be to justify increasing the base salary either at the time of hire or at evaluation time.

Once a candidate has completed this background investigation, she is in a much better position to counter the initial compensation offer. Accepting a job offer is really no different than any other business deal. Always counter. Always look for creative ways to augment the offer on the table. Always tie compensation requests, whether in cash or other incentives, the value the candidate brings to the company. Base salary is only one-way companies compensate employees.

Short-term Incentives-Bonuses:

Many employers seek to encourage outstanding performance by offering bonuses paid at regular intervals, either on an annual basis or some other basis. These performance bonuses have become quite controversial because of executive compensation for some publicly traded companies resulting in large eight or nine figure payments depending upon the performance of the company. For the job candidate the terms of the annual bonus can be a very profitable area of negotiation.

This is an excellent opportunity at the onset of the employment relationship to greatly enhance overall compensation tied to an employee’s performance and production for the company. At this the time during an interview to find out exactly what the company needs and offer to deliver that need for the company in return for a specific performance bonus. For example, a basketball coach is hired by a small university. The university does not have an outstanding basketball tradition and therefore has very low turnout in attendance for its games. The coach negotiates at the start of the contract that he would like an unusual performance bonus at the end of the season. He would like to have a dollar for every ticket sold above the total number sold the previous year. The school agrees. After a year or so annual attendance goes from 3,000 tickets sold per game to over 15,000 sold per game and with over 15 home games a year, this quickly adds up for the coach. The school is happy to pay the bonus.

For a negotiated performance bonus arrangement to be successful it must be very clear from a front end what the employee has to do in order to qualify for the bonus and the method of keeping score must be very transparent. For example, building on the previous explanation of a basketball coach, the definition of tickets sold must be clearly understood by both sides. If the coach believes that “tickets sold” includes anyone going through the turnstile, but the school believes that is excludes the band and the cheerleaders, then unless that issue is resolved on the front end a very serious dispute could arise. Similarly, when negotiating a performance bonus or evaluating an offer of employment, the employee and the employer must understand what material definitions are required and negotiate them on the front end and reduce them to writing.

Long-term Incentive Payment Plans:

There are several types of long-term incentive payment plans which a company can offer. One is a variation of performance bonus, and that is a performance bonus based on performance and productivity over a longer period of time, say three or five years or more. This can be calculated as a multiple of the base salary or as a multiple of certain performance metric, i.e. sales. The company and the employee can have various benchmarks to measure productivity against industry pier groups, other companies, long term objective growth of the company, etc. Again, these types of incentive payment plans can be specifically aimed at encouraging productivity and efficiency with specific goals in mind. There are other long term incentive payment plans which are more general in nature and basically encourage the employee to work towards the optimum productivity and profitability of the company.

These types of plans can also include out right grants of ownership (equity) in the company in the form of stock options, grants of restricted stock, non-qualified stock options, incentive stock options, stock appreciation rights and phantom stock plans. These types of plans are generally only available to highly compensated executives and each type of equity transfer has various tax benefits to the company and the executive.

Executive “Perks”

Executive Perks are benefits provided to some executives above and beyond the compensation provided to all other employees. Generally, executive perks include office space, parking, cell phones, annual physical, company car, club memberships, first class air travel, corporate aircraft, employment contracts, legal and financial services, severance agreements, change in control agreements, special deferred compensation, SERP and supplement disability and life insurance.

Employment Contracts

In “at-will” states very few employees have guaranteed terms and conditions of employment. Some executives insist on negotiating employment contracts provide some measure of security through the use of the term contract and provisions covering performance, termination and compensation. In return the company wants terms limiting post-termination competition and confidentiality of trade secrets, customer lists, etc…the result should be an arm lengths agreement which provides mutual protection for both the executive and the company.

Supplemental Executive Retirement Plans (SERPS)

            SERPS are unfunded non-qualified plans that provide additional retirement compensation and benefits to the top tier of executives and directors. Many plans provide for benefits that range from 60% to 80% of the executive’s final average salary. The plans are structured like defined benefit plans, and the provide a lifetime differential payment between the targeted overall retirement benefit and the benefits the executive receives from tax qualified plans and social security.

Change in Control & Severance Agreements

Change-in-Control Agreements, also known as “Golden Parachutes,” provide the executive with protection against the risk of losing their employment if the company is acquired. These agreements motivate the executive and create further dedication to the company during turbulent times, this can provide an element of stability in such circumstances.

Once the triggering event(s) occur, the executive receives an enhanced gross up severance (“parachute”) payment and benefits, potentially subject to a 20% federal excise taxes (IRS 280G) for any payment that exceeds three times the “disqualified individuals” (IRS 4999) base salary. There are single (change in control or voluntary termination) and double triggers (a change in control and subsequent termination).

Executive Life Insurance Plans

            Many companies offer executives additional life insurance coverage beyond the company group plan. The most common reason companies provide additional life insurance coverage is to remain competitive in attracting top talent. The executive benefits by receiving retirement income (ownership of the cash value life insurance policy), wealth building, and estate tax minimization.

Relocation Packages

Companies offer relocation programs that provide benefits to alleviate the financial and emotional stress of moving from one location to another. The executive generally expects to negotiate enormous benefits through these plans, in order to minimize financial and tax risks of the transition. Companies desire to remain competitive and retain top talent.

Make Whole or Leave Behind Payments

“Make Whole” payments, also known as sign on bonuses or “Golden Hellos,” are non-performance related payments used to compensate the new executive for loss of performance related compensation left behind with the former employer. The size of these generous make whole payments can be staggering and are dependent on the executive’s level, industry and company.

Other Employer Provided Benefits

There are many other benefit plans which companies provide to employees. These plans are governed by the Employee Retirement Income Security Act (ERISA) which sets uniform minimum standards for establishing employee benefit programs in a fair and financially sound manner. These plans are usually company-wide and are very rarely subject to negotiation. Most employees do expect certain basic benefits such as health insurance and some sort of retirement vehicle.

ERISA does not require employers to provide any particular benefits outside those required by other laws, such as workers’ compensation, unemployment insurance, or disability insurance. However, once a plan is established. ERISA imposes high standards of fiduciary duty on plan administrators. These duties include the requirement that all decisions concerning the plan are made solely in the best interests of the plan participants, that the decision-maker exercise the diligence and care of a “prudent person” given all circumstance, and that the only purpose of the plan is to provide benefits to the participants. (See Krohn v. Huron Memorial Hospital, 173 F. 3d 542 (6th Circuit,1999)).

Employers must provide any benefits they promise. Employers must provide participants with a summary plan description. This document must explain, in understandable terms, the participant’s rights, benefits and responsibilities under the plan. Administrators are also required to file annual reports that include financial information and other information concerning the operation of the plan. Employees should be very familiar with the terms and conditions contained in these summary plan descriptions.

There are many different types of employer provided benefit plans which are covered by ERISA. Some types include:

  • Retirement benefits
  • Health benefits
  • Disability benefits
  • Death benefits
  • Prepaid legal services
  • Vacation benefits
  • Day care centers
  • Scholarship funds
  • Apprenticeship and training benefits
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