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Executive Compensation in Privately Held Companies: Attracting, Motivating and Retaining Top TalentHal WallachDecember 1, 2016
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Agenda
• Setting Pay Philosophy
• Pay for Performance
• Annual Incentives
• Long-Term Incentives
• Employment Contracts
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Setting Pay Philosophy
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Key Questions in Setting Compensation Strategy
What is the market for determining our
competitive positioning (e.g., industry, size,
location, for profit and non-profit)?
1How will we position
compensation levels against the defined market (e.g.,
market median, above/below market, fixed
versus variable pay)?
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What is the right mix between fixed and variable, short-term and long-term? How do compensation and
other elements of total rewards complement each
other?
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What is the right linkage between performance and
pay?
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Compensation Market Depends on Several Key Factors
• Industry
• Company size• Revenue (assets for financial organizations)• Rule of thumb: ½ to 2x
• Ownership structure (e.g., private vs. publicly held)
• Location
• Other factors can include: historical performance, economic conditions, business strategy, organizational reputation
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Positioning Pay Relative to the Market
• Default positioning typically at predetermined range above/below median of defined market
• Positioning above or below market often due to compelling business reason(s)• Above market: Company can yield high returns on
incrementally better talent, or company is relatively risky place for employees to work, or company pay mix emphasizes “at-risk” (e.g., annual / long-term incentive) pay
• Below market: Company can attract top talent due to non-monetary rewards
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Impact of Company Life Cycle on Pay
• Pay positioning (and mix) often influenced by business life cycle phase. Example:
Relative To MarketSalary / Bonus
Long-Term Incentives
Benefits / Perquisites
Business Life Cycle/Phase
Start-Up Below Above Below
Growth Near MarketAt or Above
Market Average
Maturity At Market At Market At Market
RenewalAt or Above
MarketAt or Above
MarketAt or Above
Market
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Pay for Performance
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Measuring Performance – Beyond Just Financial
StrategicLeading indicators
Tend to be qualitative
Basis for management decisions
Examples Customer satisfaction
New product sales
Cross-selling
Market share
OperationalLeading or lagging indicators
Quantifiably measured with enhanced line-of-sight
Examples Quality
Safety
Productivity
Cost reduction initiatives
Financial Lagging indicators
Quantifiable
Reflects results/progress to date
Captures economics of the business
ExamplesRevenue / sales
Profit (gross, operating, net, EBIT)
Margin (gross, operating, net)
Return on assets (gross, net)
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Picking the Right Measure(s)
• Most companies have one “key” measure (with others to support it); an effective key measure should:• Recognize the organization’s capabilities and people, and provide
senior management with a singular performance focus in support of the company's business strategy
• Reflect the external dynamics of the industry and the economics of the business
• Correlate with ownership value creation
• Be fairly easily determined from accounting numbers and the company's financial systems ‒ simple to calculate and communicate
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Determining the ‘Right’ Level of Performance
• Performance goals should be meaningful…and achievable
Meaningful Achievable
Aligned with Ownership Value Creation
Reasonable, given competitive market environment
Sufficient "stretch" required for upside rewards
Perceived by participants as attainable, especially at "threshold"
Calibration between performance required and pay expected Linked to realistic budgets
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Annual Incentives
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Objectives
• Provide variable, performance-based pay
• Provide competitive cash compensation opportunity
• Control fixed costs (salaries)
• Support/reinforce the business strategy, company culture and core values
• Clarify roles and responsibilities
• Motivate specific behavior and reward results
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Design Issues
• Incentives vs. bonuses
• Results vs. efforts
• Team vs. individual
• Influence vs. control
• Participation
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Common Funding Approach Using Single Performance Measure
Threshold (80%) Target (100%) Maximum (120%)0%
50%
100%
150%
200%
250%
Incentive Earned as a % of Target
Performance Results
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Common Funding Approach Using Two Performance Measures
Earnings Growth
Revenue Growth
Incentive Funded as a % of Target Pool
20% 100 120 140 160 180 200
17% 80 100 120 140 160 180
14% 60 80 100 120 140 160
11% 40 60 80 100 120 140
8% 20 40 60 80 100 120
<8% 0 20 40 60 80 100
<6% 6% 8% 10% 12% 14%
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Allocating Performance at Various Organizational Levels – Example Approach
CEO/COO 100% 100%
Other Tier 2 - Corporate 60% 20% 20% 100%
CFO 75% - 100% 0% - 25% 100%
Tier 3 - Corporate 50% 25% 25% 100%
Tier 4 - Corporate 25% 25% 50% 100%
Division President 25% - 50% 50% - 75% 100%
Tier 2 - Division 20% 40% 20% 20% 100%
Tier 3 - Division 34% 33% 33% 100%
Tier 4 -Division 25% 40% 35% 100%
% of award tied to Performance of
Position/Level Corporate Division Function Individual* Total
* Includes team and/or department measures
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Long-Term Incentives
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Objectives
• Similar to annual incentive plans
• Performance measured over a period greater than one year• Three to five years most common• More emphasis on achieving goals that support a company’s
long-term strategy• Stronger link to ownership value creation
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Market Practice
• Not surprisingly, long-term incentives (LTI) are less prevalent in private (non-publicly traded) companies• In a recent WorldatWork survey of privately held companies,
just over half of respondents indicated they had an LTI plan• This compares with over 95% for publicly held companies
• Lower prevalence often attributable to• Preference of ownership to avoid equity dilution, thus
requiring additional outlay of cash• Plan designs can sometimes be complex, making plan
administration and communication difficult
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Market Practice
• Majority of LTI Plans in privately held companies are cash-based
• Overwhelming majority of companies (79%) have only one plan (versus multiple plans in publicly held companies)
LTI Plan PrevalenceLong-Term Cash Plan 44%
Stock Option 30%Restricted Stock 22%Phantom Stock 14%Performance Units 11%
Stock Appreciation Rights (SAR) 9%Performance Shares 6%
Source: WorldatWork and Vivent Consulting – Incentive Pay Practices Survey: Privately Held Companies
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Plan Definitions
Plan Type Plan Description
Stock Option A contractual right granted by the company to purchase a specified number of shares of the company's stock at a specified price (the exercise price) for a specified period of time
Restricted Stock Grants of shares of the company's stock subject to restrictions on sale and risk of forfeiture until vested by continued employment
Performance SharesGrants of actual shares of stock with payment that is contingent on performance as measured against predetermined objectives over a multi-year period of time; same as performance units except that the value paid fluctuates with stock price changes as well as performance against objectives
Performance Units Grants of dollar-dominated unites with value that is contingent on performance against predetermined objectives over a multi-year period of time. Actual payouts may be in cash or stock
Long-Term Cash Plan Cash awards where payment is contingent on performance as measured against predetermined financial or strategic objectives over a multi-year period of time (typically 3 years)
Phantom StockA type of incentive grant in which the recipient is not issued actual shares of stock on the grant date but receives an account credited with certain numbers of hypothetical shares. The value of the account increases or decreases over time based on the appreciation for depreciation of the stock price and the crediting of phantom dividends. Payout may be settled in cash or stock
Stock Appreciation Right (SAR)
A contractual right that allows an individual to receive cash or stock of a value equal to the appreciation of the stock from grant date to the date the SAR is exercised
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Plan Design – Performance Measures
• According to published survey sources, common long- term incentive performance measures include:• Profitability
• Net Income, Earnings Before Interest & Taxes [Depreciation & Amortization] – (EBIT, EBITDA), Net Profits After Taxes
• Annual Sales/Revenue
• Return• Return on Assets or Equity (ROA, ROE)
• Economic Value Added (EVA)
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Plan Design - Vesting
• Vesting period definitions:• “Cliff”– 100% vested after a specified period of time
• “Installment” – portion vested each year after grant
• Typical vesting period is three to five years (cliff or installment)
• Vesting upon retirement:• To encourage a successful transition and continuity of the
organization, many organizations are setting vesting in the event of retirement at a date in the future (e.g., one year after retirement date) rather than automatic full vesting at retirement
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Plan Comparisons
• The tables on the following pages provide high-level details/comparison of the most common long-term incentive plans in use today
• Information provided includes• Plan description (including typical vesting/performance
periods)• Accounting treatment• Company and employee tax treatment• Pros and cons of each (e.g., dilution, cash requirements, link to
pay, etc.)
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Non-Qualified Stock Options
Employer Employee
Aligns shareholder and employee interests (value entirely based on increase in stock price)
Requires higher number of shares to provide the same value relative to other LTI vehicles
Easy for employees to understand and keep track of value
Broad stock market performance may impact stock price (up or down) beyond employees' efforts or contributions
Subsequent appreciation in stock price not charged to earnings
Future sale of stock considered capital gain (tax
basis is FMV upon exercise)
Once vested, provides employees flexibility to choose when to exercise options and recognize income
Pros Cons
Tax ConsequencesDefinition / Description
Typical Vesting or
Performance Period
Accounting to Company
Right to purchase (exercise) shares of a company's stock at a stated value for a defined period of time (typically 10 years). Exercise price is typically the fair market value (FMV) on date of grant
Accounting charge fixed at grant and expensed over vesting period
Deduction at time of exercise equal to FMV of shares upon exercise in excess of grant (exercise) price
Taxable income recognized upon exercise equal to FMV of shares
upon exercise in excess of grant (exercise) price3 - 5 years
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Restricted Stock
Employer Employee
Aligns shareholder and employee interests while promoting a more immediate sense of ownership
May provide value even if company stock price declines (or performs below the market)
Supports stronger retention than options since value is not tied wholly to increases in stock price
May incent less risk taking than options
If stock appreciates, company's tax deduction exceeds fixed accounting charge
Future sale of stock considered capital gain (tax basis is FMV upon vesting)
Fewer shares typically required to produce same level of pay as stock options
Definition / Description
Typical Vesting or
Performance Period
Accounting to Company
Tax Consequences
Pros Cons
Outright grant of shares with restrictions on when they can be sold or transferred
Accounting charge fixed at grant and expensed over vesting period
Deduction equal to FMV of stock upon vesting
Taxable income recognized equal to FMV of shares upon vesting
3 - 5 years
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Performance Shares
Employer Employee
Deduction equal to FMV of shares when earned
Taxable income recognized equal to FMV of shares when earned
Strong link of pay-to-performance. Value tied to both achieving multi-year performance goals as well as stock price
May provide value even if company stock price declines
Fewer shares typically required to produce same level of pay as stock options
Requires effort to select appropriate performance measures and levels over multi-year periods
Popular plan among shareholders and proxy advisors
Pros Cons
Grant of shares which only vest (are earned) upon attainment of pre-defined performance goals over a multi-year period
3 years
Future sale of stock considered capital gain (tax
basis is FMV upon vesting)
Variable accounting
(quarterly profit & loss
fluctuations based on
performance against goals)
Definition / Description
Typical Vesting or
Performance Period
Accounting to Company
Tax Consequences
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Cash-Based
Employer Employee
Deduction when amounts earned/paid
Taxable income recognized when award earned/paid
No stock dilution since awards paid in cash
No (or smaller) link between shareholder and employee interests since performance goals not typically linked directly to stock price performance
Promotes employee focus on company strategy and performance beyond one year (vs. annual incentives)
Requires effort to select appropriate performance measures and levels over multi-year periods
Cash payments required
Definition / Description
Typical Vesting or
Performance Period
Accounting to Company
Tax Consequences
Pros Cons
Opportunity to earn a cash
award based upon
attainment of pre-defined
performance goals
measured over multi-year
period
3 years
Variable accounting (quarterly profit & loss fluctuations based on performance against goals)
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Employment Contracts
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Employment Contracts - Objectives
• Companies generally enter into employment contracts only with their most senior executives. Provisions commonly found in employment contracts include:• Term of contract and provisions for renewal• Specific duties and responsibilities• Compensation• Benefits/perquisites• Upfront/signing awards• Termination (e.g., severance benefits and outplacement
assistance)• Special change-in-control provisions• Non-compete, non-solicitation and confidentiality provisions• Dispute resolution
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Employment Contracts - Objectives
• Contracts have become more prevalent, with nearly half of all major companies reporting having contracts with one or more executives• CEO and a few direct reports most likely to have contracts
• Anecdotally, common reason given for having contracts is to "formalize" employment relationship• New hires asking for contracts
• Most important element of most contracts involves setting forth termination provisions• Most common amount for executives is one year of salary• Severance generally based on salary only• Full or partial COBRA subsidy is common• Common to offer outplacement services
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Questions?
Hal WallachDirector
Executive Compensation Consulting CBIZ Human Capital Services
314-692-5819hwallach@cbiz.com
CBIZ Human Capital Services is a business and financial advisory firm providing a vast array of services, including compensation consulting. Our professionals perform compensation valuations on a regular basis and
are qualified to provide such.
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Hal leads CBIZ Human Capital Services’ Executive
Compensation Consulting practice.
With more than 25 years of experience, he helps
management teams and boards of directors create and
institute executive compensation programs that attract and
retain top leadership, adhere to regulatory requirements,
and drive maximum return on compensation investment.
He previously served as an adjunct professor at Washington
University in their Executive MBA program where he led
classes on executive compensation.
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