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by Chris Crawford, CCP, CECP, and Josh Henke, CCP, CECP, Longnecker & Associates
Compensation is always a hot topic among Doeren Mayhew clients, but especially so in light of the growing gap in workers ages 30 to 50 that’s leaving owners worrying over their succession plans and how to retain senior leaders. Guest bloggers Chris Crawford and Josh Henke of executive compensation firm Longnecker & Associates say there are a number of strategic and tactical factors that can and should be considered to help create the right compensation package. Here, they offer six non-performance factors for compensation decision makers to consider:
What other companies pay for similar roles and responsibilities should be the starting point. This scientific analysis is such a critical input to determining pay that WorldatWork has dedicated an entire certification course — Market Pricing: Conducting a Competitive Pay Analysis — to accredit compensation and benefits professionals. Inputs such as job description, roles and responsibilities, company industry, company size and geography are all key considerations in market pricing.
While critics sometimes scoff at the approach of ―keeping up‖ and the seemingly self-inflicted ratcheting effect that occurs, the reality a company faces is if it doesn’t pay its people competitively with the market, somebody else will. According to The Carrot Principle, by Gostick and Elton, a rule of thumb for the cost of replacement is 2x – 3x base salary, and the new incumbent will be paid at the market rate regardless of how high or low the exiting incumbent was compensated.
Highly competitive industries continue to face retention issues as M&A activity has been heating up through 2012 and continuing in 2013. What some governance experts fail to realize is there is a need for retention in certain industries and will simply become a cost of doing business in those industries. If a company wants to compete in an industry such as this, pay for retention is a reality. Providing proper handcuffs on key employees through retention grants of restricted stock can and should be considered in high competitive industries. There certainly is a cross-over between pay for retention and pay for performance, and a properly designed compensation program should take into account both as the labor market continues to tighten.
The single-most important asset to an organization is its employees. However some companies fail to realize this is a key investment decision, not simply an expense decision. Just like with any investment, the outcome is uncertain until value is realized. With employees, this often gets manifested through a compensation philosophy that targets total rewards above the market median. What may seem like a larger investment into setting the best compensation structures going forward is much better than the reverse of a high-turnover/cheap work environment where employees are not satisfied.
In dealing with justifying pay for highly compensated individuals, sometimes experts are required to justify or uphold compensation decisions made by a company. The Internal Revenue Code has determined under Section 162 that a taxpayer may deduct compensation if reasonable through nine specific factors. A few key factors are the employee’s qualifications and work experience, the size and complexity of the business, compensation of comparable positions, and the amount of compensation paid to the incumbent in previous years. The last factor under IRC 162 offers a seemingly simple compensation strategy to reward key employees for all of their years of service. For example, this is particularly helpful when a CEO has served a company well for a significant number of years, yet has been compensated relatively low versus the market. The resulting compensation for prior year’s service analysis offers a board of directors a judicious and reasonable way to compensate the CEO for all of the value created over time.
Many times a start-up company will attract a key player from a much larger company. This does typically come at a cost. In order for an experienced executive to make the leap of faith, they command a premium to their existing total rewards package. If a company were to use a traditional approach of normal market pricing based on the start-up size, it may never be in a position to attract that valuable player. One approach is to offer the large company player the ―chance‖ to earn significantly more than their existing total rewards package through long-term incentives. How much more? Total Annualized Rewards x 2 is a good starting place.
Companies continuing to refine their variable pay programs balance the need for formulaic versus discretionary measures. A purely formulaic program may show alignment to actual performance but may not necessarily drive intended results. The use of discretion as a component of variable compensation allows management teams and compensation committees to align individual performance with the intangibles a formula cannot capture. As accurately stated by one compensation committee chairman, ―A spreadsheet at the beginning of the year cannot determine performance better than I can at the end of the year.‖
Not all pay is justifiable, but there are certainly more factors in the equation than the headlines would lead you to believe. Companies need internal and external factors in making compensation decisions throughout all levels of the organization. Bottom line: Find the best employees, train and invest in your employees, and the returns will come.
Chris Crawford, CECP, CCP, is COO and Executive Director at Longnecker & Associates in Houston, TX. He can be reached at firstname.lastname@example.org.
Josh Henke, CECP, CCP, is Managing Director at Longnecker & Associates in Houston, TX. He can be reached at email@example.com.
This publication is distributed for informational purposes only, with the understanding that Doeren Mayhew is not rendering legal, accounting, or other professional opinions on specific facts for matters, and, accordingly, assumes no liability whatsoever in connection with its use. Should the reader have any questions regarding any of the news articles, it is recommended that a Doeren Mayhew representative be contacted.
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