As we move from the New Economy to the Next Economy, issues such as underwater options, economic slowdown, and a lack of good talent make one ponder how can we continue to attract, retain, and motivate the top talent in our organization. Most technology related businesses are faced with a new economic and organizational reality that they are uncomfortable with. The late 90's and early part of this century made Executive Compensation planning easy. However, we now must address how to continue to motivate our top talent when the Executive Compensation model we have used over the last few years seems in jeopardy.
Anyone who has tracked executive compensation over the last fifteen years or so should not be surprised by the huge increase in the amount of total compensation that is being received by members of the senior management team, nor should anyone be surprised by the variety of compensation elements that make up executive compensation packages. Whereas the emphasis had been on base salary and cash bonuses, it has been replaced by variable, at-risk compensation elements consisting mostly of stock, which is aimed at retaining the executive and focusing attention on the goals that contribute to the long-range success of the company.
This is an important point. Equity has always been used as a long-term wealth accumulator. However, with the run up of the stock market, the IPO frenzy we witnessed over 1998-2000, and the desire for material goods, the recipient of equity rewards has changed the focus. Stock options and other equity rewards have come to be regarded as part of the current compensation program, and not a long-term vehicle. Now, with underwater options, and depressed stock prices, these same people who valued the equity are now questioning the validity of its use as a compensation tool. It is now the responsibility of Boards of Directors and Compensation Consultants to return to basics and clearly communicate the purpose and message inherent in equity ownership. The desire is for the top talent in an organization to have a significant piece of their wealth tied up in their Company so that they will continue to act in the best interest of the shareholders. The shift from cash to equity-based packages is not unique to the hi-tech world; it has been occurring over the last two decades in general industry as well.
To illustrate the shift of compensation away from cash, pay packages for CEOs of the Fortune 500 companies in 1985 indicated an average total compensation of $430,000, with the salary (fixed) portion constituting about 50%, while the variable portions consisting of annual incentives/bonuses and long-term programs each made up 25% of the total package. If we jump ahead to 2000, the value of the total compensation package had increased by over 700% to $3,500,000. Even more surprising was the shift among the three main components. Base salary had become the smallest portion, representing less than 25% of total compensation, while the variable elements made up the biggest portions, with 25% consisting of annual incentives and 50-60% consisting of long-term compensation. These numbers are, of course, averages representing the top position in very large companies, and any one company could easily have compensation figures that would be very different than these numbers. Other executive positions and top executives in mid to smaller sized companies typically receive lower levels of total compensation. However, the trend toward larger total compensation packages, with the at-risk, variable components comprising a significant portion of the package, can be found regardless of company size or industry.
A recent study our Internet Practice Group conducted, analyzed the compensation packages of CEOs within sixty (60) e-commerce, dot-com, and communications companies who completed their Initial Public Offerings in 2000. We found the following:
Average - Base Salary $211,300
Bonus $103,200
Total Compensation $311,700
Securities Underlying Options/SARs 565,300
Shares Beneficially Owned (after offering) 4,326,700
% of Class Owned (after offering) 9.4%
The relevant points should not be overlooked. Cash compensation is projected to be a small portion of the Total Compensation picture. These CEO's held over 9% of the companies after the offering, so therefore a significant portion of their wealth was tied up in equity.
In considering the value of the total compensation package, one must look closely at the long-term compensation components. Currently, the long-term piece constitutes the largest portion of the current executive compensation package. More and more companies are implementing diverse and sophisticated long-term compensation programs that serve to accomplish a number of goals, that include: 1) attracting key individuals to work for the company; 2) focusing attention on the achievement of corporate financial and operational goals; 3) rewarding these individuals with additional compensation based on their level of achievement on pre-established goals; and 4) ultimately enhancing the retention and commitment of these key members with stock programs that focus on the long-term success of the organization. Many of these long-term programs are intended to build wealth and potentially can serve as income replacement at the time of the executive's retirement. As a result, many of these long-term programs include additional vesting options and deferral provisions that serve to maximize the value of these awards. Whether this trend towards large long-term awards will continue, given the recent downturn and uncertainty in the stock market, is not known; only time will tell. It is certain, however, that an ever-increasing portion of executive compensation will be made up of variable pay elements.
When trying to establish an appropriate compensation level, it has become increasingly important to examine each element of the compensation package very carefully. Long-term stock programs can include grants of qualified or non-qualified stock options, restricted stock, contingent stock options or outright stock grants, and may be designed to stand-alone or operate in conjunction with stock appreciation rights, phantom stock grants, or other similar "cash-based" plans. Since an underlying concept of most executive compensation programs is to maximize the ultimate value to the executive by postponing or minimizing the taxable impact to the individual, these programs combine some type of deferral element, such as outright deferred compensation with vesting and restriction periods. Therefore, any evaluation of executive compensation must explore every possible type of pay program, rather than only seeking information on the most obvious components such as salary and bonuses. Knowing what makes up the typical executive compensation package, particularly within various industry groupings, will facilitate the identification of important information that will help to build the "big picture" of the total value of the compensation package.
The latest trends in the hi-tech sector include more usage of restricted stock, off-cycle option grants, company loans for exercise of options and/or payment of taxes and increased usage of non-qualified deferred compensation programs. Although the longer-term perspective will continue to be the thrust of Executive Compensation packages, the reality is that the Executive's themselves have refocused on the current cash aspect of their plans. So, it is now more important than ever to ensure your program is competitive, flexible, and creative enough to serve as a retention tool for your top talent. As we embark on the Next Economy, attracting, retaining, and motivating top talent continues to be a major issues within organizations, both large and small, hi tech and low tech. We advise sticking to tried and true, proven methodologies to ensure that the programs you develop today do not become tomorrow's problems. We believe that "compensation is a philosophy, a strategy and a solution SM." It is a tool that can be utilized to help you win the talent wars in the New Economy, the Next Economy, and whatever lies ahead.
