Executive compensation

What is executive compensation?

Executive compensation includes both the financial and non-financial rewards and benefits offered to a company's senior leadership in return for the work and impact they make at their company. It's more than just a paycheck; it's a strategic blend of short-term and long-term incentives designed to align executive and C-suite performance with company objectives and shareholder interests.

The core components of an executive compensation package typically include:

1. Base salary

2. Performance bonuses 

3. Long-term incentive plans (LTIPs)

4. Executive perks and benefits

Each of these elements plays a unique role in attracting, motivating, and retaining top-tier talent while incentivizing execs to improve company performance and shareholder profits.

Components of executive compensation plans

Executive compensation packages include both fixed and variable components. Fixed compensation includes things like salary that don’t vary based on performance, while variable compensation includes bonuses, which are contingent upon hitting certain goals. 

Base salary

Base salary is the guaranteed amount an exec will get, regardless of company performance. While it provides financial stability, base salary usually only represents a small slice of their total compensation.

When deciding what to offer, you’ll want to evaluate:

• Industry benchmarks and competitive rates (like the founder and non-founder CEO benchmarks available in Carta Total Compensation) 

• Organization size and financial health

• Executive's expertise and track record

• Scope and complexity of responsibilities

Performance bonuses

Performance bonuses, also referred to as short-term incentive plans (STIPs), are merit-based rewards linked to specific targets or KPIs, typically assessed over a one-year period. They may be tied to targets like revenue, growth, or expense management ( dilution and cash burn). These bonuses are designed to motivate executives to achieve more immediate results and annual goals.

When designing your bonus plan, you’ll want to consider:

• Establishing clear, quantifiable performance metrics

• Ensuring bonus targets align with company objectives

• Setting appropriate payout thresholds and ceilings

• Striking a balance between individual and company-wide performance measures

Long-term incentive plans (LTIPs)

LTIPs are structured to reward sustained performance and align executive interests with long-term shareholder value, like increasing sales and earnings, which drive up dividends and stock price. 

These awards are often given in the form of equity-based compensation because this gives executives a direct stake in the company's success and aligns their interests with shareholders. LTIPs are earned over time and can be based on predetermined metrics or tenure to incentivize execs to stay with the company. These often make up the biggest portion of an executive's total compensation.

Common LTIP vehicles include:

• Performance-based stock awards

• Restricted stock units (RSUs)

• Stock options

• Multi-year cash incentive plans

Executive perks and benefits

Executive perks are additional benefits provided to senior leaders that rank-and-file employees don’t get. While they’re not as popular as they used to be because of increased scrutiny, some examples of executive perks and benefits include:

• Company vehicle or car allowance

• Executive health and wellness programs

• Financial planning services

• Exclusive club memberships

• Executive severance ( golden parachutes)

You should weigh the value and perception of these kinds of perks to make sure they align with company culture and investor expectations. 

Best practices for executive compensation packages

While there’s no one-size-fits-all approach to creating executive compensation packages, there are some best practices that will help you create fair but competitive packages. 

Conduct regular market analysis

Assessing compensation packages against industry peers and market trends will help you remain competitive. This might involve using compensation consultants, participating in industry surveys, or using specialized benchmarking tools. Companies should aim to review their executive compensation packages annually, adjusting as necessary to retain top talent without overpaying.

Balance short-term and long-term incentives

You want to create compensation packages that drive short-term company and individual performance while still encouraging long-term company value creation. A well-designed package might include annual bonuses tied to yearly financial targets, alongside long-term stock options or performance shares that vest over three to five years based on sustained company growth.

Consider shareholder perspectives

Be mindful of shareholder views on executive pay, particularly for public companies subject to say-on-pay votes, which require companies to periodically provide their shareholders a vote on the compensation of the most highly compensated executives. Companies like General Electric have revamped their executive compensation structures in response to shareholder feedback, demonstrating responsiveness and building trust. Regularly engaging with major shareholders and proxy advisory firms—which help investors understand risks associated with board proposals like executive compensation—can help align compensation practices with investor expectations.

If you’re a private company, it’s a good idea to create a compensation committee to determine fair and competitive compensation and to align with your board on philosophy, budget, dilution, and offers. 

Customize packages for individual roles

Recognize that different executive positions may require varied compensation structures based on their specific responsibilities and impact on company performance. For example, a Chief Technology Officer's package might heavily weight stock options to align with long-term innovation goals, while a Chief Revenue Officer's package could emphasize performance-based cash bonuses tied to financial metrics.

Align with corporate strategy 

Ensure your compensation structures incentivize behaviors and outcomes that support your company's long-term vision and performance. For example, if your company is looking to expand internationally, your executive compensation could include performance metrics tied to global market penetration or revenue growth in target regions.

Implement recoupment provisions 

Include mechanisms to recover compensation in cases of financial restatements or executive misconduct. For instance, Wells Fargo implemented a strong clawback policy following its account fraud scandal, allowing the bank to recoup millions in executive compensation. These provisions serve as a deterrent against unethical behavior and protect shareholder interests.

Challenges in executive compensation

Designing and implementing executive compensation packages comes with several hurdles:

Income disparity concerns

High executive pay can trigger public scrutiny and criticism, especially when compared with average employee wages. For instance, the CEO-to-worker pay ratio at some large U.S. companies has exceeded 1000:1, leading to negative press and calls for reform. Companies must navigate the delicate balance between attracting top talent and maintaining a sense of fairness across the organization.

Regulatory compliance

Unlike private companies, public companies must adhere to Securities and Exchange Commission (SEC) disclosure requirements and tax laws, including the Dodd-Frank Act, which outlines reporting requirements like the Chief Executive Officer pay ratio disclosure. Public companies must also file an annual report on Form 10-K, which discloses their financial results for the previous fiscal year including executive compensation. It’s important to track evolving regulations to ensure your compensation practices comply with local and international securities laws, which can be particularly challenging for multinational corporations.

Balancing shareholder interests

Private companies need to reconcile the needs of executives, owners, investors, and employees when creating compensation packages. While executives often seek guaranteed competitive salaries, owners and investors may prefer more performance-based pay to ensure alignment with company goals and to preserve cash.

Performance measurement 

Identifying and implementing appropriate performance metrics that accurately reflect an executive's contribution can be challenging. For instance, using stock price as the sole metric might incentivize short-term thinking or risky behavior. Companies must develop a balanced scorecard of metrics that captures both financial and non-financial performance indicators, such as revenue, growth and expense management. 

Talent retention in a competitive market

As the job market for top executives becomes increasingly global and competitive, companies must find innovative ways to retain talent without overextending resources. This might involve offering unique perks, emphasizing work-life balance, or providing opportunities for personal and professional growth. Companies also face the challenge of retaining executives who may be lured away by startups offering potentially lucrative equity packages.

Addressing pay equity

With an increasing focus on diversity and inclusion, companies are facing pressure to ensure pay equity across gender, racial, and other demographic lines at the executive level. This requires careful analysis of compensation data, addressing unconscious biases in pay decisions, and potentially implementing corrective measures to close any identified gaps.

Having a compensation philosophy, market anchor points for specific jobs, and ensuring you have a fair and equitable way for assessing performance that’s metric driven can help mitigate inequity.