How to Pay Your CEO
How can a man paid just $80,000 a year become the richest person in the world? Yes, we’re talking about Jeff Bezos, the space-faring founder and former CEO of online retail giant Amazon, whose net worth is currently pegged at just south of $200 billion. The secret to Bezos’s massive wealth lies in his compensation package or his “executive pay.” This package can also provide your organization with clues in how to compensate top execs in ways that attract top talent while simultaneously boosting company performance.
First, when most people consider the term “executive pay” or “executive compensation,” they think in terms of salaries. After all, yearly salaries are how most white-collar workers and executives are remunerated. But, as illustrated so dramatically in Bezos’s case, when it comes to top leadership at large organizations—particularly publicly held companies—salaries are often just a small part of the equation. (If they play any part at all.)
Accordingly, determining the appropriate compensation package can be an art unto itself as well as a significant factor for acquiring the type of leaders you wish to attract and retain. The following are other common instruments that in addition to providing for base salaries, can be components of executive compensation packages, and the pros and cons of each.
Guaranteed Annual Bonuses. A guaranteed annual bonus is a cash amount paid to the executive, normally at the end of the calendar year. In effect, this is just part of the executive’s annual salary, but deferred. As noted by the Harvard Law School Forum on Corporate Governance, guaranteed annual bonuses are usually a terrible idea as they provide a “perverse incentive for risk-taking.” After all, executives guaranteed bonuses will be paid whether or not their initiatives succeed, so why not go for broke?
Discretionary Bonuses. Like the guaranteed annual bonus, a discretionary bonus is, as defined by the U.S. Department of Labor, any incentive whose amount and timing is determined by company leadership. In other words, the size of the bonus, and who receives it, is arbitrary. Companies doing well will often issue such lump-sum payments as “Christmas Bonuses” or “Year-End Bonuses.” The problems with discretionary bonus are multifold, and can include:
They do little to nothing to encourage future job performance.
They tell the person little to nothing about why they received the bonus.
They give employees no clue as to what they need to do the next year to receive another bonus.
Outside of a short-term morale boost, they provide no Return on Investment to the employer.
Non-Discretionary Annual Bonuses. These are a common and effective way to compensate CEOs and other organization leaders. Based upon company annual financial metrics and clearly defined in writing before the beginning of each fiscal year, this is the most effective short-term variable pay vehicle. Even so, it’s necessary to ensure such plans do not inadvertently incentivize negative behaviors, and to be sure of the intended results in support of overall company goals and objectives.
Stock Options. Stock options are a common way for publicly held companies to compensate and incentivize top leadership. The idea is fairly simple: After a period of time – called the “vesting” period -- an employee is given the opportunity to buy a certain number of shares of company stock at a set price. If the stock price has gone up during the vesting period, the employee can purchase these shares at a discount – often a significant one – and thus realize instant profits. But, as noted by Investopedia, stock options don’t really incentivize executives as intended. Yes, the executives can do well if the company posts big profits and stock prices rise, but they stand to lose nothing if the company falters and stock prices plummet. After all, they’re not obligated to exercise their options. It’s purely discretionary. In short, it’s a one-sided arrangement, with the company on the losing end.
Stock Ownership. Under this arrangement, the executive is paid in company stock in lieu of cash. As explained by the Center on Executive Compensation, direct stock payments are sometimes tied to certain performance goals, such as hitting profit levels. Or sometimes they’re linked to market performance. Of all the executive pay models discussed above, this is the only one that provides an equitable balance between the interests of the company and its employee. It incentivizes the executive to do well, for if the company’s profits rise, its stock value is likely to do the same. Conversely, if the company does poorly under the executive’s leadership, the executive suffers as well. Being paid in stock in effect makes the executive an owner, and thus has a considerable personal stake in the company’s performance.
I have been a company compensation and culture specialist for more than 30 years. If you’re looking for the best way to attract and keep high-performing executives, my team and I can help you design an executive compensation package that meets your company’s specific needs and financial goals. For more information, please contact me at laura@conoverconsulting.com.