Executive Bonus Planning: An Overview of Short-Term Incentives

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Executive Bonus Planning: An Overview of Short-Term Incentives

Executive pay planning can be an intimidating process, even for seasoned HR professionals. In the upcoming series of posts on the topic, we hope to enlighten you on the basics of executive pay, as well as get into the details on topics like restricted stock grants and deferred compensation. We’ll start with this up-close look at short-term incentives, or a bonus plan.

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To get expert input on executive pay planning, we spoke with Anna Natapova of Farient Advisors, LLC, an executive pay consulting firm based in New York City. Ms. Natapova is a compensation professional and the VP of Farient’s New York office. The following is a transcript of our conversation with Ms. Natapova.

We’ll follow up this post with information on long-term incentives and the how they function differently at private versus public companies. You can look forward to more interviews like this one. Please write us with your questions about executive pay for Ms. Natapova.

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Short-Term Incentive Pay

Ms. Natapova: A typical executive compensation program is multi-faceted and is weighted towards incentive pay. This means that it goes up and down with performance and is directly linked to the individual performance of the executive and financial and strategic performance of a particular business unit that person is head of, or, if it is a CEO, the total company. But, if you look at the top leadership of a company, the compensation really varies a lot year-to-year and it is meant to do that, since typically it is directly tied to company performance.

Salary is typically a small portion of total compensation, depending on the size of the company and the different compensation vehicles that are available. Usually, this element represents anywhere from 20-30 percent of total compensation. The remainder is typically tied to incentive compensation (short and/or long-term). And, that also takes many forms.

The incentive portion of total compensation is typically structured as a leveraged vehicle. In other words, an executive’s bonus typically has the ability to zero out if company or individual performance is below threshold levels or pay out as much as two times the target amount in a banner year.

Boards and senior management will look to set a bonus plan to drive behavior that is appropriate for the company and executives. Performance measurement can be based on a financial/strategic milestone, or individual characteristics. Typically, at the executive levels, at least half of the bonus is dependent on quantifiable elements (such financial performance like sales growth, EPS growth, return on capital), productivity or safety metrics, and there is limited emphasis on qualitative aspects, milestones like strategic initiatives, project completion and individual performances. However, as you go down the line, the weighting shifts to the qualitative aspects. It is all about establishing a clear line of sight of the executive and make sure the incentive is tied to shareholder interests as well as motivational to the executive.

Bonus plans are typically delivered in cash and paid on an annual basis. However, some companies will choose to pay a portion of the bonus in stock (very typical in financial services industry). A more frequent payout cycle, such as quarterly or semi-annually, is typical for sales incentive plans and growth companies.

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