Executive Compensation Decisions Require Big-Picture View
Successful executives know that a company’s most important financial decisions can be carried out with confidence given sufficient analysis and deliberation. Yet they may find it difficult to make choices involving their own benefits packages. Executive compensation plans have grown increasingly complex over the past decade. Devoting the time and focus needed to constantly monitor personal accounts and maximize compensation opportunities may not be feasible.
It is important for executives to look at their overall financial picture and to balance objectives that can conflict with each other, such as the desire to minimize income taxes versus the need for current cash flow. We can help with those decisions.
Whether you seek help from an adviser to think through the process or prefer to tackle it on your own, we recommend keeping the following points in mind as you face executive compensation decisions:
Understand the nuances of your benefits package.
Strategies for handling the different components of a comp plan – restricted stock grants, stock options, base pay, bonus, annual incentives, long-term incentives and more – will vary greatly from one senior executive to the next based on personal situations and can shift over time. That is why it is important to not only review your pay package annually but to be aware of trends that signal how it may be changing, which also can help you view any outside job offers in context.
In the past few years, companies have been emphasizing performance pay within the overall package while giving executives lower base pay. They also are more likely to adjust compensation plans based on the performance of the company’s stock. And there is increasing use of restricted stock, which typically awards and vests upon the satisfaction of certain conditions, such as long-term employment or specified company or performance achievements.
The new tax law also will likely cause some employers to revise their pay packages since the tax deductibility of executive compensation has changed. Most notably, it modifies Internal Revenue Code Section 162(m) to limit organizations to $1 million in deductions for compensation paid to senior executive officers, removing the exclusion for performance-based pay.
Stock options, long the dominant form of award, have become less common since a 2006 change in accounting rules that required them to be a charge against earnings. Today they are more likely to be awarded as part of a menu of performance equity awards along with performance shares and restricted stock. Nevertheless, understanding this aspect remains essential.
Considerations should include future performance of company shares, tax implications, cash flow or funding needs, executive ownership guidelines and diversification benefits. A decision on whether to exercise stock options today can be the difference between thousands and millions of dollars in retirement.
Optimize your deferred compensation payment.
When deciding whether to defer or not, it is important to recognize that deferral choices cannot be rescinded. The easy way to choose might be to assume that more earnings tomorrow beats less earnings today, but most scenarios require more complicated consideration than that. You have to cover your expenses and maintain your lifestyle, too.
We can help our clients make this choice. I have a client who every year wants us to help him make the decision on whether to defer. Tax strategies, cash flow needs, cost basis and future considerations all are discussed and analyzed closely.
Another client talked about his choices with me from his early 50s until electing to retire and take deferred compensation in his late 50s. It is not a decision made quickly if you want to optimize your payout.
Be aware of potential pitfalls.
Tax ramifications are the most obvious pitfall to be avoided. This requires a thorough analysis of your compensation package and what taxes would be triggered in various instances. Stock options, to cite just one example, can create an AMT tax trap.
Overexposure to your own company also is a risk and one that should not be underestimated. You need to recognize and manage exposure to your company.
Higher-level executives are typically required to own a certain amount of company stock, which can conflict with their wish to diversify. When an award comes closer to retirement age, that risk may be more manageable. But the future performance of your company and its shares needs to be taken into close consideration when managing your compensation package.
Integrate executive compensation with your overall financial planning.
I cannot stress enough the importance of tying decisions to your financial planning objectives. You should obviously have a good understanding of your own and your family’s goals before considering a compensation action. Then make the decision in the context of your entire financial plan. You should integrate it with the different elements of financial life: cash flow planning, retirement planning, tax planning, investment planning.
Determining where you are on the path toward meeting your objectives will go a long way toward making quality decisions about compensation.
Fully understanding and maximizing compensation opportunities within your company can be a tall order to achieve on your own. What might seem like prudent decisions you arrive at may actually add to the uncertainty of your financial future.
It is a good idea to seek professional guidance whenever you become eligible for complex plans but at least several years before you plan to retire. Having a trusted adviser to act as your personal chief financial officer on compensation matters can steer you toward the wisest decisions.
The material shown is for informational purposes only and should not be construed as accounting, legal, or tax advice. Altair Advisers LLC is a registered investment adviser with the Securities and Exchange Commission; registration does not imply a certain level of skill or training. While efforts are made to ensure information contained herein is accurate, Altair Advisers cannot guarantee the accuracy of all such information presented.