Compensation for Business Leaders

Incentives

Business leaders may receive 20% - 90% of their compensation in the form of base pay with incentives making up the difference.

These incentives may be:

• short term
• OR
• long term

Non-Equity Incentives. This compensation component typically reflects variable cash-based incentive plan payouts tied to performance factors that are important to the continued success of business units, and the company overall. In SEC-filed proxy statements, the summary compensation table discloses cash incentive awards typically in the non-equity incentive plan column. These cash payouts could have both short-term and long-term time frames and the overall plan provisions could be specific to the executive group or broad-based for all management employees. The values reported in the disclosure are the amounts earned during the year and indicate the performance criteria was satisfied.

Short-term Incentives Plan (STIPs)

STIPs typically come in the form of cash bonuses and the manager receives a lump sum for meeting a target during the stipulated measurement period, typically one year for first-line managers. In PFP, this target may be defined as:

• job-related
• organizational
• OR
• a combination

Job-related Targets. Typically related to goals and objectives or performance.

Organizational Targets. These are common for most managerial bonuses and even organization-wide bonus plans.

Financial metrics used to measure performance may be any of the following:

1. Revenue: this is the total amount of money received by the company for goods or services sold during a performance period. Revenue is calculated before any expenses are calculated and includes net sales, exchange of assets, interest, and increase in owner's equity.
2. EBITDA: earnings before interest, taxes, depreciation and amortization. Revenue minus expenses (excluding interest, taxes, depreciation and amortization)
3. Earnings per Share: the organization's net income divided by the average number of shares of common stock outstanding.
4. Operating Income: also called operating profit or EBIT. Revenue minus expenses (excluding interest and taxes).
5. Net Income: this is revenue minus cost of doing business (depreciation, interest, taxes, and other expenses).

Common non-financial metrics include:

1. Management by objectives (MBOs)
2. Performance
3. Customer satisfaction
4. Operational efficiency

The motivational value of organizational objectives depends in large part on whether the manager's actions have an impact on these measures, thereby improving the "line of sight" to overall business results.

• Top management: Members of this group can significantly impact organization-wide measures making them appropriate criteria for determining their incentive pay.
• Middle management: Members of this group can significantly impact the shorter term (quarterly, semi-annual, and annual) organization-wide measures that focus on execution. If they are successful, they can earn a substantial amount over base pay, an incentive to keep their attention focused on the organization's goals.
• Front-line management: Members of this group can significantly impact department or business unit-wide measures that may be used to determine incentives at this level.

Combination Plans. Organizations may choose to focus managers on a number of measures (including a combination of financial and non-financial measures) that they feel are important to business success. Weighting each measure is necessary when using multiple criteria. Avoid those that overlap or cannibalize each other.

Advice often quoted regarding an incentive plan:
Keep the incentive plan simple, ideally including two or three measures.

In order to be effective, your executives must know how they're being rewarded and why.

Benchmarks. Much like setting salary levels, it is often necessary to know the performance of a select peer group of organizations. This can be done by benchmarking financial performance against peer organizations using important metrics such as revenue, assets, net income, market capitalization, etc.

Knowing the financial benchmarks that exist for peer groups aids the Board of Directors in setting organizational performance goals and objectives.

STIPs for first-line managers are ordinarily determined and expressed in relation to their base salaries (e.g., target incentive is 10% of base salary). With some incentive plans, goals with quantified objectives are set and if the manager achieves or exceeds the stated goal, he or she receives a percentage of base pay.