Executive Compensation and the Role of the Compensation Committee

Pay Positioning Strategy

A critical decision in designing the executive compensation program is determining how the organization wants to align their compensation to compete with market pay practices. This is referred to as setting a "Pay Position Strategy" and requires specifying the market target for each compensation component (e.g., the 50th percentile for base salary vs 60th percentile for annual cash incentive).

A "performance-leveraged" pay strategy that targets incentive opportunities higher than base salary (e.g. the 75th percentile) requires that the relative target pay positioning be supported by the relative target performance positioning (e.g. performance goals).

There are 3 defined pay options

1. High-pay option - needed when attracting and retaining top executives is difficult.
2. Low-pay option - used for bringing in a new executive who is untried or where the performance of the current executive(s) is not what the board desires.
3. Market-pay option - the most prevalent approach but it can place the organization in a catch-up position when the labor market becomes tight.

Why pay the executive group more than market? The executive group in the organization has a number of characteristics that affect the compensation-level decision in the direction of paying this group at or preferably above market. Some of those characteristics are:

• Critical to the organization - executives are highly skilled and it can be difficult to recruit and retain these employees.
• Sunk costs - if the executive is a long tenured employee, the organization has spent considerable money in training this person as he/she moved up the executive ranks.
• Group size - even though wages are high for the group, their overall impact on total wage costs of the organization may be small.
• Knowledge - executives are very aware of the market rates for their jobs.
• Labor supply - there is a small supply of qualified executives as compared with other employee groups.

Market versus internal orientation. Internal decisions often relate to feelings of equity between positions within the organization. The CEO typically earns more than other top executives and the pay is often 2 to 4 times greater. The more entrepreneurial the organization, the wider the gap tends to be.