Executive compensation is a crucial aspect of the corporate world. As employees enter top-level management positions, they bear the weight of increased pressure and consequences of strategic decision-making that helps grow the organization. From that standpoint, they expect to be compensated for their efforts in a way that considers all aspects of their achievements.
Financial and non-financial benefits make up an executive employment package. Both of these aspects are crucial to attracting top talent to your company and retaining it for those succeeding in their roles. When considering what to have in your executive compensation package, identifying industry standards, aligning with employee interests, and clearly defining your compensation philosophy is key.
What is Executive Compensation?
Executive compensation is a complex subject that includes many different components of compensation like incentives and benefits. The foundation of most executive compensation packages is a base salary, which is the fixed amount of money that employees receive annually. However, base pay is only one piece of an executive compensation package.
The other components of an executive compensation package can include direct and indirect types of compensation. For example, an executive may have their annual incentive or bonus tied to different facets of business performance or profitability. As you move up the ranks in the organization, you are judged more on the success of your teams, groups and overall organization rather than an individual performance rating. Another critical component of executive compensation is long term incentives. Those typically consist of various forms of shares and stock options. Most importantly, executive compensation can be customized to suit the needs and preferences of the executive and the company’s overall compensation philosophy.
The Importance of Executive Compensation
As outlined above, executive compensation packages are meant to attract and retain top talent. According to Economic Policy Institute, CEO pay has increased more than 1000% since 1978. While this number seems high, executive compensation is also an essential indicator of the success of an organization. When a company takes the time to craft executive compensation packages that reflect the value and worth of the employee, it creates the ability to drive business performance. When executives feel they are fairly compensated, they wield significant influence over team morale, resource allocation, and overall behavior, leading to a more productive and successful organization. A culture where executives curate an environment where people want to work will always have a better bottom line.
Components of a Typical Executive Compensation Package
An executive compensation structure can be built on the foundation of a few crucial components. What you choose to add or develop from those largely depends on your organization’s compensation philosophy. Here are a few considerations that many use to determine a compensation structure:
- Base Salary: This is the fixed amount of money that executives receive on an annual basis.
- Bonuses: Bonuses are additional payments that executives receive based on their performance or the performance of the company. Bonuses can be paid out in cash or stock options.
- Stock Options: Stock options give executives the right to purchase company stock at a predetermined price at a future date. The value of the stock options can increase or decrease based on the performance of the company’s stock.
- Restricted Stock Units (RSUs): RSUs are a form of equity compensation where the executive receives company stock that vests over time. The executive does not have to pay for the shares upfront, but they may be subjected to certain restrictions.
- Performance Shares: Performance shares are a form of equity compensation that is tied to the performance of the company’s stock over a specific period. The executive receives company stock if the performance targets are met.
- Pension Plans: Pension plans are retirement savings plans that provide executives with a guaranteed income stream during their retirement.
- Perks: Perks are additional benefits that executives receive as part of their compensation packages, such as company cars, club memberships, and travel allowances.
Designing a Customized Executive Compensation Package
When putting together executive compensation packages, it’s vital to understand both indirect and direct forms of compensation. These specific components can and should look different from organization to organization, especially since the breadth of the role and its responsibilities can differ based on industries and sectors. With that said, here are some fundamental steps to consider when designing a customized executive compensation package:
Determine the Compensation Philosophy
A company’s compensation philosophy should align with its overall business strategy. Consider furthering your understanding of how your enterprise values different aspects of the executive’s role, such as performance, leadership, and long-term vision.
Identify the Executive’s Goals
You should take the time to understand the executive’s needs and goals as you assemble their compensation package. This doesn’t have to be done directly, but discussing their priorities, such as equity ownership, aspiration, financial compensation, or work-life balance, can be an asset.
Research Industry Norms
Benchmarking your executive compensation packages against industry norms ensures they remain competitive and attract top talent. You might consider reviewing executive compensation surveys and practices of peer companies.
Select Compensation Components
Based on the company’s compensation philosophy, the executive’s goals, and industry norms, select the compensation components that make sense for the executive’s role. This may include base salary, bonuses, equity compensation, pension plans, and other perks.
Set Performance Metrics
Compensation components such as bonuses and equity compensation should be tied to specific performance metrics that align with the company’s goals. Set clear objectives that are measurable and achievable.
Review and Adjust
It is essential to regularly review the compensation package and adjust it as needed to ensure that it remains competitive and aligned with the executive’s goals and the company’s strategy.
Executive compensation is a significant aspect of corporate governance aimed at attracting and retaining top talent in the industry. Although designing an executive compensation structure can take time, you can ensure your company stays competitive and maintains thriving executives with the right software. Book a demo with us to learn how.