Trend by Kevin Logterman, Managing Director, Family Business and Industrial Practices
Given the controversy surrounding executive pay, private companies may be relieved that their compensation packages are protected from the glare of public disclosure. Private company compensation, however, may be failing to attract the right sort of attention. No one will argue with the idea that creating competitive executive compensation is vital to attract and retain supreme talent. Private companies will certainly be more likely to bask in the glow of success if their compensation strategies contain compelling incentives. That being said, many private companies have been unable to create the right mix of compensation that will attract and retain the best and brightest executive talent.
Kevin Logterman specializes in executive level assignments for family-owned and private equity businesses with Cook Associates Executive Search. Recently he spoke about his experiences with private companies and what, in particular, family-owned enterprises can do to attract and retain top-notch talent. Also lending expertise to the conversation was a colleague of Logterman’s named Neil Lappley, who has worked as a compensation and human-resource consultant for more than twenty-five years. We will explore some of the issues the two often encounter when working with companies to create competitive and compelling executive compensation for family-owned and private businesses.
Compensation Tool Kit
In a recent review of several years’ worth of executive compensation projects, both Lappley and Logterman note some distinct questions clients seek answers to, such as: How do I compare to other companies in the industry? Should I have an annual plan in place? What should be the base, executive-level salary? Is my compensation plan competitive in my industry, my marketplace? How can I best retain my executive talent?
When looking at the competitiveness of salary it is advisable for private companies to acquire competitive means data and compare their compensation levels to those in the report. Most companies – be they private or public – have salary programs in place and some type of annual bonus. Where the major differences lie is in long term incentives plan. In comparing across sectors, between 80 and 90 percent of public companies have a long-term plan. Contrast that number with private companies, who have long-term incentive plans at almost half the pace of public companies, and the difference is striking. The reasons for the gap are inherent difficulties involved with valuing and setting incentive goals.
Many public companies use stock options, or restricted options, and have readily valued options in the marketplace. Since they are public companies the worth of their plans are well-known and thus easily calculated. Well-managed private companies generally remain competitive when it comes to salary and annual incentives, but where they may miss the mark in attracting talent from public companies is in the use of long-term plans.
There are three distinct benefits to consider when structuring a long-term incentive plan within a private or family controlled business. First, an organization will raise its’ competitiveness for attracting talent away from public companies. Secondly, the company will be able to measure and reward the attainment of long-term, strategic goals of the organization with the long term incentive plan. The underlying idea is that a long-term plan can balance shorter-term objectives (and potentially reduce the amount of short term bonus payout). Finally, there is the addition of golden handcuffs to raise the ante if a competitor attempts to hire away one of the company’s best employees. By structuring a competitive long-term incentive plan, an organization can retain its star players longer and keep them happier while doing so.
Phantom Stock and Performance Unit
There are two types of long-term plans and perhaps the easiest to implement is a phantom stock plan. Phantom stock is simply a promise to pay a bonus – in the form of the equivalent of the value of company shares or the increase in that value – over a period of time. In other words, under this plan an executive receives the appreciation of some type of fair market, book, or formula basis, over a set period of time, in accordance with the value of the company. For instance, say an executive is given a number of shares – 2,000 shares at $25 a share – that become vested after 5 years. At the end of 5 years the shares are worth $50 each, amounting to a lump sum of $50,000 paid to the executive.
A second option to consider – called a performance unit plan – is being used with greater frequency in private companies. Under this plan an executive is granted a number of units and a payment will be made at the end, dependent upon the performance of the organization over time. For example, in one common performance unit scenario, an executive may be awarded 2,000 units that at the end of three years will be paid out on a scale from $1 to $40 a unit, dependent upon achievement of very specific and quantifiable goals.
This long-term plan is different from a phantom plan, in that, it is not tied to equity or earnings but instead to a performance measurement. An example of measurements typically used under a performance unit plan, are the change in market share and change in cumulative sales. Implementing this long-term plan is particularly meaningful because it directly ties an executive’s performance to what he or she may earn. Whether your company favors a phantom stock or performance unit plan, both types of long-term incentives contribute to the formation of a rock-solid strategic compensation plan.
Compensating Strategically
A final theme Lappley and Logterman encounter repeatedly with clients is a lack of strategic direction. Oftentimes, to remedy this breach, companies are advised to evaluate specific metrics traditionally overlooked by family-owned and private companies. During the course of the strategic evaluation company leadership should also develop a sound compensation philosophy tied to company strategy.
When creating a compensation philosophy and strategic plan consider carefully how performance is measured and what overall objectives are important to the company as it moves forward. Family-owned businesses need to take a close look at what they are trying to accomplish and tie incentives to specific performance measures. In a growth situation, for instance, it would be appropriate to place heavier emphasis on sales, market share, or product development. Conversely, if the status quo is more important, or if the return to shareholders is valued, then look at profitability measures like return on equity or return on assets.
Conclusion
Generally, compensation at privately held companies is less transparent and more discretionary than what is found in public organizations. Bonus and incentive decisions are held close to the vest, often as a result of operating outcomes being communicated only to a select group of individuals. In the collective experiences of Lappley and Logterman, they find owners of companies can be reluctant to set explicit criteria for compensation actions like performance management and appraisals, salary increases, and bonus payments. However, building a cohesive compensation plan that includes base salary, annual bonus, and long-term incentives is critical when seeking top-notch talent. By heeding this advice, private companies too can create the right mix of compensation that will attract and retain stellar executive talent.