Executive Compensation

I was asked to speak to a group of prominent, local CFOs and Audit Committee Chairs last night on compensation risk assessment. As someone accustomed to working with Compensation Committees, it was interesting to hear the different perspective of these folks. They raised several interesting issues that I will incorporate into future Blogs.

One of the first questions asked by this group of individuals with significant audit/risk experience was: What do you mean by compensation plan risk?

The following are a few very simple examples of compensation program features that could provide too much incentive for executives to take risk or otherwise manipulate financial results:

• The Company's annual (or long-term) bonus plan that provides for a payout equal to 100 percent of base salary if the Company achieves a specified EPS Target — and no payout if the Company fails to achieve that target.
  
  
  Executives are already under enormous pressure to achieve announced or expected EPS figures. This all-or-nothing approach would only exacerbate the problem. Instead, the Company should consider bonus payouts at 90 percent of base salary for achieving EPS that is barely below the Target and straight-line interpolation downward for other, lesser performance targets.
  
  
• The Company provides equity incentive compensation solely in the form of stock options. Many of the stock options are underwater.
  
  Executives need to "hit a grand slam home run" in terms of performance in order to see any return on their stock options. Slow, but steady, growth may not be enough. Ideally, the Company would provide part of its equity compensation in restricted stock or RSUs, so that executives will receive some benefit for navigating through difficult financial times.

• The Company maintains an employee compensation program that provides cash incentive pay based on the number of transactions the employee makes, without a qualitative requirement (e.g., did the transactions create profit for the Company and, if so, at what risk?).

Because every company of every size in every industry has a different risk profile, there can be no "one size fits all" program for conducting the required risk assessment. For example, an equity compensation award of 100 percent stock options may be appropriate for a small growth company in the technology sector, whereas a mature manufacturing company in a cyclical industry may want to award restricted stock.