Monday, September 26, 2016
Pay packages at the senior executive level have become increasingly creative and complex, from start-ups to Fortune 500 companies. Things like stock options, restricted stock, deferred compensation and significant bonuses are common denominators in many compensation packages. However, strategies for managing and accounting for these different pieces of a comp plan vary greatly based on an executive’s personal situation. There are a few key trends that are paramount for executives to be aware of, especially with regard to their holistic financial plan, in order to maintain their desired lifestyle and protect their financial future.
The Evolution of Base Pay and Performance-Based Compensation
Over the last few years there has been a growing trend of much lower base pay for executives. There are executives who ultimately earn seven figures or more, but their base pay is within the $150,000 to $175,000 range. There is much greater emphasis on performance pay, which correlates directly with company equity. While performance pay has been utilized for a long time, there is a growing disparity between base pay and an executive’s entire compensation package. Some executives actually struggle to live off of their base pay as it is much lower than what they have grown accustomed to in previous executive roles.
Additionally, there has been a trend or willingness of companies to adjust compensation plans based upon the performance of the company stock. For example, a company will put together an offer with a specific base pay (often low), a bonus, and an equity incentive. If the company’s stock declines, the company might revise the executives compensation package, providing a higher base pay and/or more generous stock grants in order to ensure executive retention.
The Shift Towards Stock Grants vs. Stock Options
There is a noticeable difference between mature companies (e.g. Fortune 500 companies)and younger companies including startups when it comes to stock grants and stock options. Mature companies are much more apt to offer restricted stock grants as opposed to stock options. Historically, most companies offered stock options, but at times this leads to disappointing equity compensation as a company’s share price must move in the upward direction before the stock option holder can realize value from their options. Restricted stock grants may provide executives with the ability to realize some value out of the equity compensation without the explicit need for stock price appreciation.
Microsoft is an excellent example of this particular trend. Their compensation department offered stock options for years, and while their stock was doing well in the 90s, this was an excellent option for executives. But with the tech bubble and subsequent bust of the early 2000s, Microsoft found themselves with a very serious and pressing compensation issue. Executives weren’t earning their expected pay because the stock was underperforming. The compensation department went back to the drawing board to determine the best strategy for retaining executives and paying them fairly. They made the switch to the restricted stock model, in which an executive receives stock grants that they can access through investing over an extended period of time. The model provides an ongoing incentive for executives to stay with the company, as staying can provide access to significant amounts of company stock vesting each year.
The Role of Equity Compensation, Deferred Compensation, and Taxes in an Executive’s Financial Plan
When an executive is considering a proposed compensation plan, it is critical that they take their entire financial plan into consideration. It is necessary to look at current cash flows, what’s coming in and what expenses are going out. Determining where an executive is in their earning and saving cycle – for instance, are they nearing retirement? – will have a massive impact on potential risk as well as savings capacity. Overall, compensation packages need to be considered in their entirety and within the context of a financial and life plan before they can be accepted.
When it comes to various elements of compensation packages, equity and deferred compensation can have a profound impact on long-term outlooks as well as taxes. Should access to a deferred compensation plan be available, executives may have the ability to save upwards of 40% on their current income taxes. While not every company offers deferred compensation plans and options, both are something to strongly consider and inquire about, as long as your holistic financial plan allows for it.
With regards to equity compensation and holding company stock, some companies have holding requirements to get to two times the annual base pay within a certain amount of time. In general, it isn’t recommended to have too much concentration in one particular stock, as diversification really is the name of the game. Having said that, it’s important to note that some of the world’s wealthiest individuals got that way by concentrating their wealth in one company. On the flipside, some of the largest falls from grace and financial horror stories revolve around concentrated stock. Some of the very executives and institutional investors who already had significant exposure to failing companies in 2008 and 2009 bought more just before they went bankrupt!
The Importance of a Personal CFO
For executives, navigating, analyzing and negotiating compensation packages can be an incredibly challenging process and if it is not done successfully it could have a detrimental impact on a financial plan. If an executive doesn’t have the time or knowledge to properly assess their compensation package, we strongly encourage them to seek professional guidance. At Brighton Jones, our team of advisors serve as personal CFOs on behalf of executives who are essentially the CEO of their financial future. As a fiduciary, Brighton Jones is always working in the best interest of our clients and therefore it is mutually understood that at the beginning of a relationship, any recommendations made are solely focused on improving the client’s financial plan. It is always our goal to give clients the best information for their unique situation so they can make informed decisions.
When we first sit down with a client who has an offer on the table, we make sure to review the entire offer; restricted stock grants, stock options, base pay, bonus, access to deferred compensation, etc. The most important element for considering a compensation package is placing that offer within the larger financial context of that executive. What does the income mean relative to their plan? What are their plans for spending their income? How can we help them utilize this income to fund their life plan? Does the plan include things like disability benefits or vesting in retirement? Once we have a better idea of the larger context, we’re able to better model what that income and those benefits should amount to over time. At times, we are also able to recommend to executives whether or not they should go back to the table to renegotiate elements of the package.
As previously noted, compensation packages for senior executives are becoming increasingly complex. Thankfully, many executives have access to resources that can help them understand how compensation packages play a role within their financial plan. If you have questions regarding executive compensation or wish to better understand the role of a Personal CFO, we encourage you to reach out to our team today.
Now you know that executive compensation is more complicated than ever and if you have equity, you probably have questions. Download our free white paper on navigating stock plans to help set yourself up for a successful future.
Greer Smith serves as an advisor at Brighton Jones.