EXECUTIVE COMPENSATION

Many organizations, especially large ones, administer executive compensation somewhat differently than compensation for lower-level employees. An executive typically is someone in the top two levels of an organization, such as Chief Executive Officer (CEO), President, or Senior Vice-President.
As Figure shows, the common components of executive compensation are salaries, annual bonuses, long-term incentives, supplemental benefits, and perquisites.

Two objectives influence executive compensation: (1) ensuring that the total compensation packages for executives are competitive with the compensation packages in other firms that might employ them, and (2) tying the overall performance of the organization over a period of time to the compensation that is paid to executives. It is the second objective that critics of executive compensation believe is not being met. In many organizations, it appears that the levels of executive compensation may be unreasonable and not linked closely to organizational performance.



Elements of Executive Compensation

At the heart of most executive compensation plans is the idea that executives should be rewarded if the organization grows in profitability and value over a

Executive Compensation Components

period of years. Because many executives are in high tax brackets, their compensation often is provided in ways that offer significant tax savings. Therefore, their total compensation packages are more significant than their base pay. Especially when the base salary is $1 million or more, the executive often is interested in the mix of items in the total package, including current and deferred compensation.

EXECUTIVE SALARIES

Salaries of executives vary by type of job, size of organization, region of the country, and industry. On average, salaries make up about 40— 60% of the typical top executive’s annual compensation total. A provision of a 1993 tax act prohibits a publicly traded company from deducting pay of more than $1 million for each of its top five officers unless that pay is based on performance criteria approved by outside directors and shareholders.



EXECUTIVE BONUS PLANS

Because executive performance may be difficult to determine, bonus compensation must reflect some kind of performance measure if it is to be meaningful. As an example, a retail chain with over 250 stores ties annual bonuses for managers to store profitability. The bonuses have amounted to as much as 35% of a store manager’s base salary.

Bonuses for executives can be determined in several ways. A discretionary system whereby bonuses are awarded based on the judgments of the chief executive officer and the board of directors is one way. However, the absence of formal,  measurable targets is a major drawback of this approach. Also, as noted, bonuses can be tied to specific measures, such as return on investment, earnings per share, or net profits before taxes. More complex systems create bonus pools and thresholds above which bonuses are computed. Whatever method is used, it is important to describe it so that executives trying to earn bonuses understand the plan; otherwise, the incentive effect will be diminished.


PERFORMANCE INCENTIVES—LONG TERM VS. SHORT TERM

Performance-based incentives attempt to tie executive compensation to the long-term growth and success of the organization. However, whether the emphasis is really on the long term or merely represents a series of short-term rewards is controversial. Shortterm rewards based on quarterly or annual performance may not result in the kind of long-run-oriented decisions necessary for the company to continue to do well.

A stock option gives an individual the right to buy stock in a company, usually at an advantageous price. Different types of stock options have been used depending on the tax laws in effect. Stock options have increased in use as a component of executive compensation during the past 10 years, and employers may use a variety of very specialized and technical approaches to them, which are beyond the scope of this discussion. However, the overall trend is toward using stock options as performance-based long-term incentives.

Where stock is closely held, firms may grant “stock equivalencies” in the form of phantom stock or share appreciation rights. These plans pay recipients the increased value of the stock in the future, determined by a base valuation made at the time the phantom stock or share appreciation rights are given. Depending on how these plans are established, the executives may be able to defer taxes or be taxed at lower capital-gains tax rates.



BENEFITS FOR EXECUTIVES

As with benefits for non-executive employees, executive benefits may take several forms, including traditional retirement, health insurance, vacations, and others. However, executive benefits may include some items that other employees do not receive. For example, executive health plans with no co-payments and with no limitations on deductibles or physician choice are popular among small and middle-sized businesses. Corporate-owned life insurance on the life of the executive is popular and pays both the executive’s estate and the company in the event of death. Trusts of various kinds may be designed by the company to help the executive deal with estate issues. Deferred compensation is another possible means used to help executives with tax liabilities caused by incentive compensation plans.



EXECUTIVE PERQUISITES

In addition to the regular benefits received by all employees, executives often receive benefits called perquisites. Perquisites (perks) are special executive benefits—usually noncash items. Perks are useful in tying executives to organizations and in demonstrating their importance to the companies. It is the status enhancement value of perks that is important to many executives. Visible symbols of status allow executives to be seen as “very important people (VIPs)” both inside and outside their organizations. In addition, perks can offer substantial tax savings because many perks are not taxed as income.

Figure lists some perks that are commonly available.

Board of Directors’ Role with Executive Compensation In most organizations the board of directors is the major policy-setting entity. For publicly traded companies covered by federal regulatory agencies, such as the Securities and Exchange Commission (SEC), the board of directors must approve executive compensation packages. Even many nonprofit organizations are covered by Internal Revenue Service requirements to have boards of directors review and approve the compensation for top-level executives. In family-owned or privately owned firms, boards of directors may have less involvement in establishing and reviewing the compensation packages for key executives.



BOARD COMPENSATION COMMITTEE

The compensation committee usually is a subgroup of the board of directors composed of directors who are not officers of the firm. Compensation committees generally make recommendations to the board of directors on overall pay policies, salaries for top officers, supplemental compensation such as stock options and bonuses, and additional perquisites (“perks”) for executives. But the “independence” of board compensation committees increasingly has been criticized.
One major concern voiced by many critics is that the base pay and bonuses of CEOs often are set by board compensation members, many of whom are CEOs of other companies with similar compensation packages. However, one study found little relationship between the composition of compensation committees of boards and the level of CEO compensation.

Also, the compensation advisors and consultants to the CEOs often collect large fees, and critics charge that those fees distort the objectivity of the advice given.

To counter criticism, some corporations are changing the composition of the compensation committee and giving it more independence. Some of the changes include prohibiting “insider” company officers and board members from serving on compensation committees. Also, some firms empower the compensation committee to hire and pay compensation consultants without involving executive management.

Executive Perquisites

More importantly, the link between the independence of board compensation committees and organization performances is crucial. If the compensation committee’s decisions about executive variable pay lead to higher organizational performance, then the composition of the compensation committee is less of an issue. Research on compensation committees and organizational performance indicates that having more “outside” directors is linked to better organizational performance results, as the HR Perspective on the next page indicates.



BOARD MEMBERS’ COMPENSATION

Although they are not executives of the firm, outside members of boards of directors receive compensation as well.

Generally, they receive directors’ fees, either as a set amount per year or a permeeting fee. To counter some criticisms of the independence of board members, some experts have recommended that board members be paid totally or in part with company stock. This approach is seen as linking board members’ pay more closely to that of the stockholders they represent. Also, some corporations require
board members to purchase and own a minimum number of shares of stock in the company.

Team-Based Variable Pay

The growing use of work teams in organizations has implications for compensation of the teams and their members. Interestingly, while the use of teams has increased significantly in the past few years, the question of how to equitably compensate the individuals who compose the team remains one of the biggest challenges. As Figure notes, there are several reasons why organizations have established group or team variable pay plans, and evidently these goals are being met in a number of organizations.

As seen in the results of a survey of the Fortune 1000 large companies, almost 70% of these large firms are using work teams in some manner. About 87% of the executives and HR professionals surveyed were positive about the use of teams.

However, only 45% of those surveyed were positive about the ways those teams were being paid. Also, the satisfaction with team-based pay plans was lower than two years before, despite a significant increase in the use of teams.

Why Organizations Establish Team Variable Pay Plans

Types of Team Incentives

Team-based reward systems use various ways of compensating individuals. The components often include individual wages and salaries in addition to team-based rewards. Most team-based organizations continue to pay individuals based either on the jobs performed or the individuals’ competencies and capabilities.

Several decisions about methods of distributing and allocating team rewards must be made.

Distributing Team Incentives

The two primary approaches for distributing team rewards are as follows:

1) Same size reward for each team member: In this approach, all team members receive the same payout, regardless of job levels, current pay, or seniority.

2) Different size rewards for each team member: Using this approach, individual rewards vary based upon such factors as contribution to team results, current pay, years of experience, and skill levels of jobs performed.

Generally more organizations use the same-size team reward approach as an addition to different levels of individual pay. This approach is used to reward team performance by making the team incentive equal, while still recognizing that individual pay differences exist and are important to many persons. The size of the team incentive can be determined either by using a percentage of base pay for the individuals or the team as a whole, or by offering a specific dollar amount.

For example, one firm pays team members individual base rates that reflect years of experience and any additional training that team members have. The team reward is distributed to all as a flat dollar amount.

TIMING OF TEAM INCENTIVES How often team incentives are paid out is another important consideration. Some of the choices seen in firms with team-based incentives include payment monthly, quarterly, biannually, or annually. As Figure shows, yearly is the most common period used. The shorter the time period, the more likely it is that employees will see a closer link to their efforts and the performance results that trigger the award payouts. A study of team rewards for quality management found that companies generally limited the team rewards to $500 or less, so that the rewards could be paid out more frequently.

Naturally, the nature of the teamwork, measurement criteria, and organizational results must all be considered when determining the appropriate time period.

Characteristics of Team-Based Rewards

DECISION MAKING ABOUT TEAM-INCENTIVE AMOUNTS To reinforce the team concept, some team incentive programs allow group members to make decisions about how to allocate the team rewards to individuals. For example, in one division of Motorola, teams are given a lump sum amount and they decide how to divide up the money. Some teams vote, while others have a team leader decide.

In other companies teams divide the team “pot” equally, thus avoiding conflict and recognizing that all members contributed to the team results.

Although some teams actually make decisions on bonuses for their members, this practice seems to be the exception rather than the rule. Many companies find teams unwilling to handle pay decisions for coworkers. Team-based bonus plans present other problems as well. Should a member be rewarded for trying hard but not quite succeeding? What happens when extra money for a “superstar” has to come from other group members’ forgoing their own bonuses to some extent? Team-based incentives present both opportunities and challenges when they are developed and implemented.

Problems with Team-Based Incentives

The difference between rewarding team members equally or equitably triggers many of the problems associated with team-based incentives. Rewards that are distributed equally in amount to all team members may be perceived as “unfair” by employees who may work harder, have more capabilities, and perform more difficult jobs. This problem is compounded when a poorly performing individual negatively influences the team results. For instance, suppose that holding dataentry errors to below 2% is an objective that triggers payment of a group incentive.

The presence of one or two poor performers who make numerous errors can result in the group being denied an incentive payment for a month. Unfortunately, even if management retrains or removes the poor performers, some incentive amounts already have been lost.

Equitable pay in the minds of many people means distributing the team rewards individually to recognize individual efforts and capabilities. One survey of employees working in teams found a relatively low level of employee satisfaction with rewards that are the same for all, rather than different amounts based on performance, which may be viewed more equitably.

In summary, it seems that the concept of people working in teams is seen as beneficial by managers and organization leaders. But employees still expect to be paid based on individual performance, to a large extent. Until this individualism is recognized and compensation programs developed that are viewed as more equitable by more “team members,” caution should be used in developing and implementing team-based incentives.

Successful Team-Based Incentives

The unique nature of the team and its members is important when establishing successful team-based rewards. One consideration is the history of the group and its past performance.Use of incentives is more successful where groups have been used in the past and where those groups have performed well. However, simultaneously introducing the teamwork concept and changing to team-based incentives has not been as successful.

Another consideration for the success of team-based incentives is the size of the team. If a team becomes too large, employees may feel their individual efforts will have little or no effect on the total performance of the group and the resulting rewards. Incentive plans for small groups are a direct result of the growing number of complex jobs requiring interdependent effort. Teambased incentive plans may encourage teamwork in small groups where interdependence is high. Therefore, it is recommended that team-based performance measures be used.Such plans have been used in many serviceoriented industries, where a high degree of contact with customers requires teamwork.

Team incentives seem to work best when the following criteria are present:

1. Significant interdependence exists among the work of several individuals, and teamwork and cooperation are essential.
2. Difficulties exist in identifying exactly who is responsible for differing levels of performance.
3. Management wants to create or reinforce teamwork and cooperation among employees.
4. Rewards are seen as being allocated in a fair and equitable manner.
5. Employee input is obtained in the design of the team-incentive plan.

If these conditions cannot be met, then either individual or organizational incentives

may be more appropriate.

SALES COMPENSATION AND INCENTIVES

The compensation paid to employees involved with sales and marketing is partly or entirely tied to sales performance. Better-performing salespeople receive more total compensation than those selling less.

1. SALES PERFORMANCE MEASUREMENT

Successfully using variable sales compensation requires establishing clear performance criteria and measures. Generally, no more than three sales performance measures should be used in a sales compensation plan. Consultants criticize many sales commission plans as being too complex to motivate sales representatives. Other plans may be too simple, focusing only on the salesperson’s pay, not on organizational objectives. Although many companies use an individual’s sales revenue compared to established quotas as the primary performance measure, performance would be much better if these organizations used a variety of criteria, including obtaining new accounts and selling high-value versus low-value items that reflect marketing plans. Figure shows the results of one study identifying the criteria used to determine incentive payments for salespeople.

2. SALES COMPENSATION PLANS

Sales compensation plans are generally of several different types. The types are based on the degree to which total compensation includes some variable pay tied to sales performance. A survey of over 260 firms found that plans providing salary with bonus (37%) and salary with commission and bonus (35%) were the most used types. Less used were plans providing commission only (24%) and salary only (5%).19 A look at each type of sales compensation follows next.

SALARY ONLY Some firms pay salespeople only a salary. The salary-only approach is useful when serving and retaining existing accounts is being emphasized more than generating new sales and accounts. This approach is frequently used to protect the income of new sales representatives for a period of time while they are building up their sales clientele. It is also used when both new and existing sales reps have to spend considerable time learning about and selling customers new products and service lines. Generally, the salary-only approach may extend no more than six months, at which point sales plus commission or bonuses are implemented. However, one study found that salespeople who wanted extrinsic rewards were less effective in salary-only plans. They were less motivated to sell without additional performance-related compensation.

STRAIGHT COMMISSION An individual incentive system widely used in sales jobs is the commission, which is compensation computed as a percentage of sales in units or dollars. Commissions are integrated into the pay given to sales workers in three common ways: straight commission, salary plus commission, and bonuses.

In the straight commission system, a sales representative receives a percentage of the value of the sales made. Consider a sales representative working for a consumer products company. She receives no compensation if no sales are made, but for all sales made in her territory, she receives a percentage of the total amount. The advantage of this system is that the sales representative must sell to earn. The disadvantage is that it offers no security for the sales staff. This disadvantage can be especially pronounced when the product or service sold is one that requires a long lead time before purchasing decisions are made. Also, as the HR Perspective on the previous page indicates, commission-only plans may lead to unethical behavior of sales employees. For these reasons just mentioned, some employers use a draw system, in which the sales representative can draw advance payments against future commissions.

The amount drawn then is deducted from future commission checks. From the employer’s side, one of the risks in a draw system is that future commissions may not be large enough to repay the draw, especially for a new or marginally successful salesperson. In addition, arrangements must be made for repayment of drawn amounts if an individual leaves the organization before earning the draw in commission.

SALARY PLUS COMMISSION OR BONUSES The most frequently used form of sales compensation is the salary plus commission, which combines the stability of a salary with the performance aspect of a commission. Many organizations also pay salespeople salaries and then offer bonuses as a percentage of base pay tied to meeting various levels of sales targets or other criteria. A common split is 70% salary to 30% commission, although the split varies by industry and with other factors. Some sales organizations combine both individual and group sales bonus programs. In these programs, a portion of the sales incentive is linked to the attainment of group sales goals. This approach encourages cooperation and teamwork for the salespersons to work together. Team incentives in situations other than

sales jobs are discussed next.

STAGES IN THE JOB ANALYSIS PROCESS

The process of job analysis must be conducted in a logical manner, following appropriate management and professional psychometric practices. Therefore, a multistage process usually is followed, regardless of the job analysis methods used. The stages for a typical job analysis are outlined here, but they may vary with the methods used and the number of jobs included. Figure illustrates the basic stages of the process.

Stages in the Job Analysis Process

1. PLANNING THE JOB ANALYSIS

It is crucial that the job analysis process be planned before beginning the gathering of data from managers and employees. Probably the most important consideration is to identify the objectives of the job analysis. Maybe it is just to update job descriptions. Or, it may include as an outcome revising the compensation programs in the organization. Another objective could be to redesign the jobs in a department or division of the organization. Also, it could be to change the structure in parts of the organization to align it better with business strategies.

Whatever the purpose identified, it is vital to obtain top management support.

The backing of senior managers is needed as issues arise regarding changes in jobs or the organizational structure. Support from even the highest levels of management helps when managerial and employee anxieties and resistance arise.

 

 2. PREPARING AND INTRODUCING THE JOB ANALYSIS

Preparation begins by identifying the jobs under review. 

For example, are the jobs to be analyzed hourly jobs, clerical jobs, all jobs in one division, or all jobs in the entire organization? In this phase, those who will be involved in conducting the job analysis and the methods to be used are identified. Also specified is how current incumbents and managers will participate in the process and how many employees’ jobs will be considered.

Another task in the identification phase is to review existing documentation.

Existing job descriptions, organization charts, previous job analysis information, and other industry-related resources all may be useful to review. Having details from this review may save time and effort later in the process.

A crucial step is to communicate and explain the process to managers, affected employees, and other concerned people, such as union stewards. Explanations should address the natural concerns and anxieties people have when someone puts their jobs under close scrutiny. Items to be covered often include the purpose of the job analysis, the steps involved, the time schedule, how managers and employees will participate, who is doing the analysis, and whom to contact as questions arise. When employees are represented by a union, it is essential that union representatives be included in reviewing the job descriptions and specifications to lessen the possibility of future conflicts.

 

3. CONDUCTING THE JOB ANALYSIS

With the preparation completed, the job analysis can be conducted. The methods selected will determine the time line for the project. Sufficient time should be allotted for obtaining the information from employees and managers. If questionnaires are used, it is often helpful to have employees return them to supervisors or managers for review before giving them back to those conducting the job analysis.

The questionnaire should be accompanied by a letter explaining the process and instructions for completing and returning the job analysis questionnaires.

Once data from job analysis has been compiled, it should be sorted by job, the job family, and organizational unit. This step allows for comparison of data from similar jobs throughout the organization. The data also should be reviewed for completeness, and follow-up may be needed in the form of additional interviews or questions to be answered by managers and employees.

 

4. DEVELOPING JOB DESCRIPTIONS AND JOB SPECIFICATIONS

At this stage the job analysts will prepare draft job descriptions and job specifications.

Generally, organizations have found that having managers and employees write job descriptions is not recommended for several reasons. 

First, there is no consistency in format and details, both of which are important given the legal consequences of job descriptions. 

Second, managers and employees vary in their writing skills. Also, they may write the job descriptions and job specifications to reflect what they do and what their personal qualifications are, not what the job requires.

Once the drafts are completed, they should be reviewed by managers. 

Whether employees review the drafts or wait to receive the final job descriptions is often determined by the managerial style of the supervisors/managers and the culture of the organization regarding employee participation and communication.

When finished, job descriptions are distributed by the HR department to managers, supervisors, and employees. It is important that each supervisor or manager review the completed description with individual employees so that there is understanding and agreement on the content that will be linked to performance appraisals, as well as to all other HR activities.