Upper Saddle River, N.J. - July 18, 2006 - There continues to be a barrage of media reports concerning new excesses relating to executive compensation. The most recent revelations have concerned issues such as
back dating of stock option grants,
grossing up bonus payments to cover related taxes, and in a recent Wall Street Journal article
[1], extremely lucrative
retirement benefits.
Referred to as Supplemental Executive Retirement Plans (SERPs), these types of retirement plans are extremely common, and have long been used as the method to replace retirement benefits which would otherwise be reduced because of ERISA limitations. Under ERISA regulations, which were enacted to insure that senior management did not get greater benefits at the expense of lower paid workers, only the first $220,000 of compensation can be used for determining retirement benefits. In addition, hiring executives in mid-career usually prohibits them from participating fully in a regular retirement program (where they still exist), or may even keep them from vesting by the time they retire. Because of these limitations, most public companies have provided some form of SERP to their more senior-level executives.
SERPs typically take the form of a predetermined level of post-retirement income replacement. The percentage of income that is guaranteed has been increasing, and it is not uncommon to see 80% or more. Although most plans contain a carve out for Social Security and other retirement benefits provided by the organization, the benefit is typically not tied to any performance requirement. This is definitely true where the calculated benefit is based on salary; when it is based on Total Cash Compensation, consisting of salary and earned bonuses/incentives, it can be inferred that at least a portion of this supplemental retirement benefit is based on performance.
In the case of for-profit, publicly-traded companies, it can be argued that most of these organizations already have other forms of Long-Term Incentive (LTI) programs (whether cash- or equity-based) that have the potential of providing extra funds to enhance retirement benefits without the need for SERPs. Privately-owned, for-profits tend to utilize fewer equity-based plans, but still offer other opportunities for capital accumulation that can assist with their executives’ post-retirement income needs. Although these may take the form of SERPs which are time based, rather than performance based, many companies have also adopted some form of performance based LTI, most commonly referred to as “phantom stock” plans.
Phantom stock plans can take many different forms, but typically provide the participants an opportunity to share in the up-side growth of the company. These may pay out at the end of a fixed performance period of three to five years, or be career-based and paid at retirement. The specifics of each plan vary, but since they are tied to performance, they typically provide motivational value to achieve desired growth and profitability objectives, while defusing criticism that the plan is a “give away” based on longevity only.
In the not-for-profit (NFP) world, the use of variable compensation is rapidly growing as an important component of the overall compensation package. Although many of these still take the form of discretionary bonus plans, there is a pronounced move towards the adoption of true, formula-based incentive plans, with defined goals and objectives. While the belief has been that not-for-profits have no "profits" to share, this perception has long since been replaced with the recognition that there are both quantitative and qualitative goals that can be defined and measured, and that if achieved, will advance the mission of the NFP. These become the performance measures that can trigger the payment of variable compensation within the NFP environment. Similarly, the longer-term goals, as well as the level of annual performance achieved, can also be used to recognize and fund enhanced retirement benefits for key management. This then can be used to replace or at least supplement the typical SERP, and tie these financial rewards to recognizable achievement. This should not only reduce criticism of a strictly give away program, but also provide a more “level playing field”, so that NFPs can better and more competitively vie for qualified executive talent with companies in the for-profit world.
