Executive compensation plan: a strategic tool for your business

Companies use competitive compensation plans to attract high-potential candidates and retain their current executives. Salary aside, companies can offer a variety of benefits to drive performance, promote retention and engagement, and ensure a return on investment. What components make up a compensation strategy and how do I know which ones are most effective at using executive compensation to drive performance?

Compensation plan components

When determining executive compensation, companies need to know what options are available to them. There is a big difference between the compensation offered to executives and to employees. This makes sense given the key role executives play in achieving company objectives.

Base salary

A base salary is the pay that an executive receives annually. This money is risk free, regardless of how the executive or company performed that year. Executives are always entitled to their base salary.

Short-term incentives

This type of incentive compensation is designed to generate results quickly. Short-term incentives can be advantageous during a major transformation as a way to spur rapid change or encourage the adoption of certain internal practices.

• Annual incentive plan: Annual bonuses are paid at the end of the fiscal year and are typically calculated based on two indices: individual performance and company performance.
• Commissions: This type of incentive compensation, which is less common for executive positions, is calculated as a direct function of sales targets.

These incentives are often paid in cash, whereas long-term incentives are paid in the form of options, shares or equity in the company.

Long-term incentives

A long-term incentive program is focused primarily on value creation. It is based on seniority or achieving long-term objectives. If executives meet the requirements of the agreement, they will receive options or equity in the company. This form of performance-based compensation is dictated by the company’s vision and helps to ensure that senior management works in this direction.

• Restricted stock units (RSU): These stock units can only be converted into actual shares at the end of a given period and under certain conditions, such as achieving performance objectives or reaching a certain level of seniority.
• Stock options: Executives are given the opportunity to purchase shares of the company at a pre-determined price and over a set period of time. For this benefit to be advantageous to them, the company’s stock must increase in value. At the same time, there is no real ceiling in terms of profit.
• Stock appreciation rights: Similar to stock options, stock appreciation rights allow executives to benefit from increases in the stock price. However, executives do not need to purchase any shares. The agreement must set out the starting price and the terms, including the payment method.
• Performance shares: Shares are allocated based on the executive’s ability to achieve objectives over a given period. Unlike restricted shares, performance shares are not issued until the conditions of the agreement have been met.
• Phantom stock or phantom equity: This program entitles executives to bonuses based on the value of the company’s shares on the payment date. This incentive program does not involve the purchase of actual shares, hence the name phantom stock.

These types of financial incentives promote retention, as they often have a clause stating that the options are forfeited upon termination of employment.

Long-term incentives can make executives a lot of money while at the same time delivering results for the company. For example, let’s say that as chair of the board you promise 10,000 shares to your new CEO, if the company’s digital transformation is successful. At the time of the agreement, the stock is worth $5 a share. Three years later, it is worth $15 thanks to the CEO’s good work. The CEO has just become $100,000 richer ($15 per share - $5 per share x 10,000 shares) and your company has tripled in value.

Employee benefits and perquisites

This component involves total compensation, that is, all employee benefits offered during the hiring process.

• Employee benefits: Benefits offered to employees, including a pension plan, a registered retirement savings plan (RRSP), health insurance, life insurance, paid leave, the employee assistance program and a gym membership.
• Perquisites: This type of benefit generally contributes to a better work-life balance. Examples of perquisites include flexible hours and working remotely.

Company heads may also be entitled to certain substantial benefits included in the hiring package, such as a car allowance, paid parking space, company-provided telephone and concierge service.

While often marginally important in a compensation program, all of these benefits can help to recruit and retain executives.

What should your company prioritize in its executive compensation?

A compensation plan has many components. There is no winning formula, but there are many internal and external factors to consider.

• What are your goals as an organization? Are you aiming for rapid growth, a quick, dramatic pivot, or do you want to stay the course in the long term?
• What performance expectations do you have toward the executive? Where is he or she in the organizational hierarchy?
• What kind of executive compensation do you offer? Do you need to maintain some level of internal equity?
• What is your company’s legal structure? What is the nature of your operations?
• Does your business have a performance culture? Is there a willingness to take risks?
• What is your company’s position in the market as an employer? Does your company attract talent easily? Do you have a good employee retention rate, specifically among your executives?
• What are the trends in the job market? Do you operate in a highly competitive industry?
• Do you have the financial resources to commit to paying a high salary? Or are you, for instance, a start-up with limited funds?