In 2018, a rule in the 2010 Dodd-Frank Act made it mandatory for publicly traded companies to disclose the pay of the chief executives to the median compensation of all employees. The transparency was striking. Vox reports that average CEO pay across all American industries rose 8% in 2018 to $7.4 million. In contrast, the median wage for employees at those companies stayed the same. Ultimately CEOs make 150 times what a typical worker did last year.
To better break down these numbers, let’s take a look at what actually goes into a CEO compensation package and how to create the right one for your organization.
Building a CEO Compensation Package with Pay for Performance
The most popular model for a CEO compensation package is to pay for performance. The pay for performance model allocates bonuses that are tied to how well CEOs meet their goals. Performance is usually gauged by a number of criteria including revenue growth, return on equity, or share price appreciation.
Although this model implies that a CEO would take on risk with their salary, CEOs who know they’re compensated for performance tend to perform at a higher level. The board of directors will often appoint a compensation committee to create and oversee the CEO compensation package. They also analyze how the CEO reached their goals and if they meet the requirements for compensation.
CEO compensation packages based on the pay for performance model are comprised of 6 different elements. Each element has its own incentive, reward, or benefit.
Base Salary
Base salaries included in a CEO compensation package differ greatly from company and industry. Just like employee salaries, years of experience are considered with calculating total compensation. Base salaries are usually paid out monthly or biweekly in accordance with the organization’s pay plan.
Due to the 1993 Federal Tax Limits Law and the 2017 Tax Cuts and Jobs Act, organizations must cap base salaries for high-paid executives at $1 million. These laws apply whether the salary is or isn’t performance-based, what the executive will receive if they retire, or if their employment is terminated.
Short-Term and Long-term CEO Compensation Package Incentives
Short term incentives are often awarded on an annual basis when executives achieve the organization’s short-term business goals. The board and compensation committee are tasked with cataloging annual goals and how the executives reached these goals in order to be compensated.
Annual or yearly goals usually include increasing the organization’s revenue, market share, and profit margins. Executives may have also implemented a new corporate strategy, developed new products, expanded the market in some way, or completed an important project.
Annual incentives are allocated in a 2-tier structure with a “target” level and a “stretch” goal. The target level is the expected outcome for the goals set forth by the board. The stretch goal is based on extraordinary results.
Long-term incentives make up the largest component of a CEO compensation package. These bonus opportunities reward CEOs when they achieve an organization’s strategic goals that will maximize shareholder value. CEOs are compensated with stock, stock options, restricted stock, or similar compensation.
CEOs can expect to see these bonuses after the end of the performance period which is usually 3-5 years. Each organization is different when it comes to long-term incentivizing for their CEO, but they are always focused on a return to shareholders. This element of the CEO compensation package also includes target and stretch goals.
Benefits
Most organizations offer benefits to their employees and the CEO isn’t any different. CEO compensation packages also include paid time off, sick days, holidays, medical insurance, and life insurance. They also include social security, Medicare, workers compensation, and unemployment insurance.
CEO compensation packages also include special retirement plans. However, these special plans come at a risk to executives. They are not protected by federal regulations, pension rules, or secured in a trust. Therefore, if the organization was unable to pay them due to an occurrence such as bankruptcy, the executives will not be paid.
Perquisites Included in a CEO Compensation Plan
Perquisites or “perks” as they are often referred are also a key element of a CEO compensation package. These benefits recognize the time and effort CEOs put in for their position and include drivers to and from work, company cars, convenient parking, financial planning, and paid travel expenses. Although this is sometimes a small portion of the CEO compensation package, perks are an asset to bringing top CEO talent on board with the organization.
Severance/Change-in-Control Agreements
A comprehensive CEO compensation package should also include severance agreements in case of a resignation or termination of an executive. These agreements are key for attracting new CEOs who take on risk when leaving a position to join a new organization.
Change-in-control agreements also help CEOs mitigate risk. These agreements are often referred to as “golden parachutes” because they compensate CEOs if they lose their job due to a merger or sale of the company.
Board Portals Enhance CEO Performance
Each element of a CEO compensation package is a key component to attracting and keeping top talent in CEOs. Secure board portal software also makes it possible to enhance CEO performance and engagement. Govenda incorporates a variety of tools to transform collaboration and organize important materials. Govenda makes it possible for CEOs to track long and short term goals that directly contribute to the success of an organization.
