Company executives make important strategic decisions and goals, and coordinate organizational operations. Having your key employees head-hunted by another organization can be a nightmare for your business, whether you’re a privately-held company or a publicly-traded company.
It is important to structure your executive compensation plan right to keep them happy and motivated.
What is executive compensation?
Executive compensation, also known as executive pay, is the combination of salary, benefits and bonuses offered to executives or other top management positions at a company in return for their work.
As they are experienced and skilled professionals at the top of their respective industries, companies often compensate them with a more valuable and complex compensation package.
Why is it important to discuss executive pay?
Executive compensation structure has been widely discussed because it’s important to get it right due to :
- Talent retention: Executives or senior management, as mentioned, are key to a company so a well-designed structure helps maintain staff stability and thus grows the company and business profit.
- Public sentiment: All public companies are required to disclose how much they are paying their executives and how this amount is derived. Not getting it right can bring negative public attention.
- Regulatory: The executive compensation policy of publicly traded companies is overseen by governmental regulations.
What are the components of a typical executive compensation package?
A typical executive compensation package has financial and non-financial components. They are salary, benefits, bonuses and equity. Commonly, an executive will receive more equity than a normal worker and a normal worker quite often wouldn’t get any equity in a private company.
- Salary: A fixed yearly salary, also known as a base salary
- Benefits: They may include insurance (e.g. health insurance and life insurance), club/gym membership, company mobile phone etc.
- Bonuses: Considered short-term or annual incentives, they’re usually non-fixed, one-off sums of money, based on KIPs
- Equity: Considered a long-term incentive (over 3 years), equity compensation represents a form of ownership in the company and motivates employees to work harder – the better the company performs, the more valuable their equity awards can become. It also provides a way to significantly grow individual wealth compared to fixed cash bonuses. Check how it works in the next section.
Executive compensation structure: It is not uncommon for salary to make up approximately 30% of total compensation, bonuses another 20%, benefits about 10%, and long-term incentives (equity) about 40%.
How does executive equity compensation work?
Equity operates quite differently from cash. You don’t fully own an equity award until the vesting period has passed. Vesting is the process by which you gradually earn full ownership of their equity through satisfying certain requirements – time-based and/or milestone-based.
Thanks to this built-in retention function, you will likely stay in a company longer to receive the benefits. Here are some common executive equity grants:
- Stock Options provide you with the right to purchase a certain number of shares at an initially agreed price at a future date after vesting.
- Restricted Stock Units are a promise from your employer to give you shares of the company’s stock as soon as you vest. So the employee doesn’t own them or become a stockholder with voting rights at the start.
- Performance stock vest based on performance targets such as financial metrics.
Our equity management software can handle virtually any equity award type or plan, all the way through the award life cycle from award (or enrollment), through vesting, and on to exercise or other disposition. Whether the award is time-based or performance-based awards, we can track their vesting via a vesting schedule.
Executive compensation plans for private companies and public companies
While the size of the gap can vary depending upon company size and industry, executives at public companies tend to receive more compensation than those with private businesses. One of the main driving factors behind this trend is the prevalence of long-term incentives at public companies.
Among the commonly seen main differences:
| Private companies | Public companies |
|---|---|
| Tend to offer equity more selectively (arising from, for example, liquidity constraints) | Offer equity more often |
| A small number of executives receive significant equity stakes | More executives receive equity, even managers |
| Offer less competitive equity-based incentives | Usually offer more competitive equity-based incentives |
| LTIP heavily relies on cash | LTIP tends to diversify awards among at least 2 equity vehicles – restricted stock & performance shares |
| Simpler processes for obtaining approval of equity grants | More time-consuming approval processes |
| Public disclosure of executive compensation plan is not required | Concise and understandable public disclosure of executive compensation plan required |
Since there’re many differences in executive compensation between private and public companies, make sure to allow yourself sufficient time to review your compensation plan if you intend to go public. To learn more, read our ‘’IPO executive compensation’’ checklist.
So, what is the most effective executive compensation structure?
The most effective executive compensation structure should be aligned with specific business goals and strategy, the time horizon of the investors and other factors like below:
- Business philosophy, mission and vision
- Life cycle, organizational structure and business processes
- Workforce composition and demographics
- Tax and accounting regulations
- Industry and competition
- Public sentiment
After carefully considering them, you’ll know whether you should rely more on equity-based awards or cash-based incentives. Once you’ve made that decision, don’t forget the next important step – equity management.
At J.P. Morgan Workplace Solutions we provide equity management solutions for businesses of all sizes the world over. Book a one-on-one, no-obligation consultation today.
By visiting a third-party site, you may be entering an unsecured website that may have a different privacy policy and security practices from J.P. Morgan standards. J.P. Morgan is not responsible for, and does not control, endorse or guarantee, any aspect of any linked third-party site. J.P. Morgan accepts no direct or consequential losses arising from the use of such sites.
This publication contains general information only and J.P. Morgan Workplace Solutions is not, through this article, issuing any advice, be it legal, financial, tax-related, business-related, professional or other. J.P. Morgan Workplace Solutions’ Insights is not a substitute for professional advice and should not be used as such. J.P. Morgan Workplace Solutions does not assume any liability for reliance on the information provided herein.
