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CHAPTER FOURTEEN
COMPENSATION OF SPECIAL GROUPS
Overview
This begins the three chapter Part Six – Extending the System. In the prior chapters, the
authors described compensation programs as if they were fairly uniform across all jobs in an
organization. However, a number of employee groups require, because of their importance to
strategic success, special consideration in the way compensation packages are designed. This
chapter focuses on several employee groups that do not fit in the basic model. Their special
employment status dictates the design of compensation policies and practices that often differ
from the more traditional designs presented in the earlier chapters.
The first part of the chapter identifies and describes the unique characteristics that apply to
special groups. The remaining part of the chapter focuses on the key considerations in
designing a compensation strategy for each of the following special groups:
Supervisors
Corporate directors
Executives
Scientists and engineers (professionals)
Sales forces
Contingent workers
The key conflicts faced by each special group are identified, along with the specific nature of
the equity concerns of each group. Based on the conflicts, consideration of equity concerns,
and research evidence, specific compensation practices which are most applicable to each
group are described.
Lecture Outline: Overview of Major Topics
I. Who Are Special Groups?
II. Compensation Strategy for Special Groups
III. Your Turn: A Sports Sales Plan
Learning Objectives
Define the characteristics of special groups and their importance to the organization.
Identify compensation strategies for supervisors, corporate directors and executives
with an emphasis on components of an executive compensation package including base
salary, short-term incentives or bonuses, long-term incentives and capital appreciation
plans, employee benefits, and perquisites.
Discuss executive compensation, distinguishing between the perspectives of the critic,
the press, and the academic.
Understand compensation for other special groups including professionals, sales staff,
and contingent workers.
Lecture Outline: Summary of Key Chapter Points
I. Who Are Special Groups?
Special treatment, either in the form of add-on packages not received by other
employees or in the form of compensation components entirely unique in the
organization, tends to focus on a few specific groups.
Special groups share two characteristics:
oThey tend to be strategically important to a company. If they don’t succeed at
their jobs, success for the whole organization is in jeopardy.
oTheir positions tend to have built-in conflict that arises because different factions
place incompatible demands on members of the group.
Exhibit 14.1 describes the nature of the conflicts faced by such special groups as
supervisors, top management, boards of directors, scientists and engineers, sales
personnel, and contingent workers.
When both the above mentioned characteristics are present, employers tend to
find distinctive compensation practices adopted to meet the needs of these special
groups.
II. Compensation Strategy for Special Groups
A. Supervisors
Supervisors are caught between the demands of upper management to meet
production goals and the needs of employees to receive rewards, reinforcements,
and general counseling.
The major challenge in compensating supervisors centers on equity. Some
incentive must be provided to entice nonexempt employees to accept the
challenges of being a supervisor.
Supervisor jobs often are exempt from overtime pay. If the job requires more than
forty hours of work per week, every extra hour is paid at straight time rather than
time and a half.
Organizations have devised several strategies to attract workers into supervisory
jobs.
oThe most popular method is to key the base salary of supervisors to
some amount exceeding the top-paid subordinate in the unit (5 to 30 percent
represents the typical size of the differential).
oAnother method to maintain equitable differentials is to pay supervisors
for scheduled overtime.
The biggest trend in supervisory compensation centers on increased use of
variable pay. Slightly more than half of all companies now have a variable pay
component for supervisors, up from 16 percent in prior years.
B. Corporate Directors
A board of directors comprises individuals from both inside and outside a firm
who provide strategic advice on decision making.
Most boards have between eight and eleven directors.
Probably due to increased attention to CEO pay and concerns about impartiality,
companies are trying to populate their boards with outside directors. Outside
directors are harder to bring up to speed about a company’s values and
environment, but they are perceived to be less prone to bias than internal
directors.
What used to be a “rubber stamp” process by internal board members beholden to
the CEO is now a highly charged analysis of, among other things, CEO
compensation. There is considerable risk in these jobs. Stockholders are prone to
sue directors when CEOs receive large pay increases despite poor company
performance on key financial measures.
In exchange for assuming this risk, directors are well rewarded, with a typical
member, working 30-40 hours per month, is compensated (median) $240,000.
C. Executives
Every spring when the major business publications announce the top-paid
executives in the country, they spark a flurry of articles detailing stockholder
disgust with CEO pay and vitriolic demands that something be done. Especially
infuriating, stockholders argue, is a reward package worth millions when, by all
financial measures, the company is doing poorly.
Even if the CEO is terminated for poor performance the outcome is often
controversial. Exit compensation, often called “Golden Parachute,” handed over
to the CEOs on termination, is growing at a staggering rate.
The disconnect between pay and performance of the nation’s top executives has
been a source of contention for over 30 years.
Components of an Executive Compensation Package
oThere are five basic elements of most executive compensation packages.
Base salary
Short-term (annual) incentives or bonuses
Long-term incentives and capital appreciation plans
Employee benefits
Perquisites
Because of the changing nature of tax legislation, each of these at one time or
another has received considerable attention in designing executive compensation
packages.
oExhibit 14.2 traces the trend in these components over time.
oExhibit 14.3 shows overall compensation for the top 5 executives in
2014.
Base Salary
oAlthough formalized job evaluation still plays an occasional role in
determining executive base pay, other sources are much more important.
Particularly important is the opinion of a compensation committee, composed
usually of the company’s board of directors or a subset of the board.
oFrequently the compensation committee will take over some of the data
analysis tasks previously performed by the chief personnel officer.
oOne empirical study suggests the most common approach (60 percent of
the cases) of executive compensation committees is to identify major
competitors and set the CEO’s compensation at a level between the best and
worst of these comparison groups.
oWhere pay fell in this range depends on a number of factors. CEOs who
are particularly likely to be raided, according to one study, were more likely to
have higher compensation than peers.
oLarger companies also tended to hit the high end of the compensation
range by selecting “peer companies” to benchmark against that were tilted
towards the high-paying end.
Bonuses
oAnnual bonuses often play a major role in executive compensation and
are primarily designed to motivate better short-term performance.
oOnly 20 years ago, just 36 per cent of companies gave annual bonuses.
Today bonuses are given to 90 percent of executives.
oThough, the portion of executive compensation allotted to bonuses is
smaller this decade than in the past.
oPart of the explanation can be traced to the motivational impact of
bonuses. Bonuses caused CEOs to approve decisions with great short-term
payouts but clear long-term dire consequences. Less of this motivation is
better.
oA second reason for lower portion of pay allocated to bonuses is their
subjectivity. Perhaps to lessen this subjectivity, 65 percent of companies in a
recent survey indicate they are introducing new financial measures for their
annual incentive (bonus) schemes.
oPart of this move is towards new objective measures that account for
different aspects of performance. Some leading companies are linking
executive bonuses to customer satisfaction.
Long-Term Incentive and Capital Appreciation Plans
oBucking a trend toward ever-rising long-term incentives (e.g., stock
options), both the dollar allocation and the portion of dollars allocated to
long-term incentives has been declining recently.
oPart of the reason for the recent decline is the furor over stock options’
tax advantages. In just the last few years companies increasingly have been
pressured to expense stock options in their annual reports, showing
stockholders the real cost of options.
oA second factor is stockholder dismay at the ease with which options are
granted and exercised.
People just went through some of the toughest stock market years in
history, yet many executives in underperforming firms are lined up for
huge incentive payouts. Only public outcry and government intervention
prevented this injustice.
Passage of the 2010 Dodd-Frank Act is one signal that executive
compensation will be monitored closely. This act gives shareholders a
nonbinding vote assessing the fairness of a CEO’s compensation package.
Companies are subjecting their CEOs to increased scrutiny. This means
greater links of stock options to performance by CEOs and their
companies.
oA third reason why traditional stock options may be declining in favor is
linked to recent illegal backdating allegations.
Some companies have been accused of backdating the granting of stock
options to coincide with dates when share prices were particularly low.
When prices rebound, executives profit greatly.
Executive decisions have an important impact on corporate success.
Responsibly linking executive compensation to stock price is a very
effective way to make sure executives are motivated to seek corporate
successes. In comparison, base wages seem like an entitlement.
Bonuses also are flawed. They pay-off for good short-term performance.
What’s good in the short-run isn’t necessarily responsible in the long-term.
Stock options, which typically are vested (meaning they can’t be exercised
for a specified length of time, often three years), have a built–in incentive
for executives to strive for long-term success.
oExhibit 14.4 describes and comments on long-term incentives for
executives.
Executive Benefits
oSince many benefits are tied to income level, executives typically
receive higher benefits than most other exempt employees.
oBeyond the typical benefits, however, many executives also receive
additional life insurance, exclusions from deductibles for health-related costs,
and supplementary pension income exceeding the maximum limits
permissible under ERISA guidelines for qualified (eligible for tax deductions)
pension plans.
oVarious sections of ERISA and the tax code restrict an employers’ ability
to provide benefits for executives that are too far above those of other
workers. The assorted clauses require that a particular benefit plan:
Cover a broad cross-section of employees (generally 80 percent).
Provide definitely determinable benefits
Meet specific vesting and nondiscrimination requirements
Executive Perquisites
oSince 1978, various tax and regulatory agency rulings have slowly been
requiring companies to place a value on perquisites or “perks”.
oExhibit 14.5 shows common perks today in Fortune 100 companies and
provides a loose comparison to perks in general for CEOs in 1990.
D. What’s All the Furor Over Executive Compensation? What the Critics and Press
Say
Empirical data shows CEO pay averages $14.3 million dollars. Many critics feel
that this level of compensation can’t be justified under any circumstances.
Part of the argument includes comparisons to other countries. Wages in the
European Union, for example, are much lower.
oWages plus incentives for French CEOs, the highest-paid EU executives
average about $2 million in a sample of the 300 largest European companies.
oU.K. salaries for CEOs are about one-half that of their American
counterparts, and other European executives fall even further behind.
Some argue that executive compensation reflects changes in the market.
Others argue that maybe executives earn their increases. Increasingly boards are
trying to make this very argument by linking pay to performance.
oLarge pay can then be explained by great company performance. A
typical argument would be as follows:
If the company performance exceeds industry standards, big bonuses and
stock payouts follow. Poor financial performance means much smaller pay
packages.
Exhibit 14.6 gives a brief history of the path executive compensation took to
reach the incredible heights. Pay attention to the way the granting of stock options
has gradually played a bigger role in executive compensation.
The world of compensation is very different in not-for-profit organizations. Top
officers in charities rarely make more than a million dollars a year.
oFurther, a large fraction of total compensation in the not-for-profit arena
—much more than in the private sector—is allocated to expense accounts and
employee benefits.
Some experts today argue that executive compensation could be reined in by
making sure the board of directors has explicit knowledge of how much CEOs
receive each year.
oAlthough it might sound strange but figuring out the worth of
compensation package in any given year isn’t exactly easy.
Only recently have companies started to capture the true value of an entire
compensation package, using a simple tool called a tally sheet.
oA tally sheet gives a comprehensive view on the true value of executive
compensation. It’s a simple concept that is making its way into the executive
board room: Tally up the value of base salary, annual incentives, long-term
incentives, benefits, and perks.
oPart of this process includes estimating the current value of stock options
(using the Black–Scholes model), stock appreciation rights, vested and
unvested pensions, and payouts upon termination.
oExperts argue that a tally sheet gives board members a single figure that
they can then debate over: Is this competitive? Does performance justify this
amount?
An alternative way to rein in executive compensation is to increase government
regulation.
oIn 1992 the Securities and Exchange Commission entered the
controversy. Stockholders are now permitted to propose and vote on limits to
executive compensation. And it appears these votes make a difference.
oOn another front, the 1993 Revenue Reconciliation Act limited employer
deductions for executive compensation to $1 million and capped the amount
of executive compensation used in computing contributions to and benefits
from qualified retirement plans.
oHowever, this very law has set a new standard: many executives who
had been making less that $1 million are finding avenues to rise up to this
amount.
oIronically, this very law may be contributing to the growth of executive
compensation. The $1 million mark now serves as a new standard: Many
executives who had been making less than $1 million are finding their pay
quickly rising to this amount.
One way to answer the question, “Is CEO compensation excessive?” is to look at
the different ways executive compensation is determined and ask, “Does this
seem reasonable?”
