State:

National
What is a compensation administration program? A formal compensation administration program is the basic management tool for ensuring that employees are satisfied, that both internal and external equity are maintained, and that control is maintained over compensation costs. Such a program will help attract top talent, retain core employees, and encourage longevity while efficiently using financial resources. Establishing an effective compensation administration program requires job analysis, job evaluation, and job pricing. Once established, it is important to maintain and update the following aspects of the program: salary banding, employee classification, salary increases, performance appraisals, and longevity increases.
Each job in the organization should be thoroughly analyzed and described. Your job description should state clearly and simply:
• Who does the work (including the qualifications, education, and job skills required)
• What the work entails
• Where the work is performed
• When the work is done (hours, how often, or what times of year)
• Why the person does the work (why is the job essential to the company)
• How the job is accomplished
For the purposes of the Americans with Disabilities Act, it is appropriate and necessary to list the essential and nonessential functions of the job in case someone asks for a job accommodation for a covered disability.
Here are five job description summaries in the engineering series, for discussion purposes:
Job Title Job Description
Junior Engineer Performs routine engineering tasks using standard procedures. Applies limited judgment under direct supervision.
Engineer B Designs and develops major engineering project systems and subsystems under general supervision. May give technical supervision to lower-level engineers and technicians.
Senior Engineer ADesigns and develops portions of major engineering projects under general supervision. Provides technical support to other departments. May supervise technicians and lower level engineers.
Project EngineerDirects an engineering design team to complete assigned engineering projects in accordance with customer specifications and within schedule and budget limitations.
Director of EngineeringReports to chief operating officer. Directs the accomplishment of product engineering objectives. Provides technical guidance and ensures sound engineering procedures and effective use of facilities.
Employers should note that a job title alone is insufficient to establish the exempt status of an employee. Instead, the status of an employee must be determined on the basis of whether the employee's salary and duties meet the requirements of the regulations. If your company has not updated its job descriptions in over a year, it is possible that the actual work performed by employees under your current job titles has changed. Therefore, you may want to confer with managers, supervisors, and the employees when updating job descriptions. Once you have job descriptions that you believe accurately reflect the jobs performed, have your legal advisor review them, and sign and date the review so that you can prove your job descriptions are up to date and determine when a new review is necessary.
Job evaluation determines what jobs are worth on an absolute basis and relative to other jobs in the organization. It can be done in a variety of ways, but usually involves assigning “points” based on complexity, impact, budget, supervisory duties, and so on, and attaching job ranks based on the total number of points. Jobs that are of greater value to the organization have a higher labor grade; jobs of lesser value fill the lower grades. The five engineering jobs might be evaluated as follows:
Job Title Labor Grade
Junior Engineer 33
Engineer B37
Senior Engineer A39
Project Engineer40
Director of Engineering43
What an employer has as a result of the job evaluation program is a hierarchy of jobs based on point values (or some other set of reliable criteria.) In other words, an employer can be assured of internal equity when it comes to matching up the various evaluation "scores" with actual wage levels because all of the jobs in the organization have been compared with each other and have been evaluated accordingly. But internal equity alone can't guarantee employee satisfaction or protect a firm from a legal challenge. An employer must be aware of what other firms in the area or industry are paying for similar jobs. Once this information has been obtained and an employer has determined that the wage and salary structure compares favorably, an employer has achieved external equity as well.
Job pricing involves establishing rate ranges; that is, minimum, midpoint, and maximum dollar values for each labor grade. By studying wage and salary surveys, employers can compare wages in the labor market to the jobs within their organization. The result is a scale of wages that allows the employer to compete in the labor market (external equity) while ensuring that jobs that are worth more to the organization are paid more than those of lesser worth (internal equity). Here's an illustration of a set of rate ranges.
Labor GradeMinimumMidpointMaximum
33$30,147$40,196$50,245
37$40,954$54,605$68,257
39$52,851$66,828$81,455
40$51,533$68,711$85,888
43$64,845$86,460$108,075
In an effort to simplify salary administration, to encourage employees to acquire new skills, and to promote lateral movement within the organization, many employers have developed and implemented salary banding programs. A salary banding system involves grouping multiple, related jobs into large, expansive salary bands. For example, a company may collect all existing secretarial, administrative assistants, and clerical grades into one large salary band titled “Administrative,” with a salary band of $9.26 per hour to $24.61 per hour. Salary movement is then primarily determined by the acquisition of new skills or merit increases, because promotions do not occur within the band because an individual has been switched from one arbitrary title to another. Banding provides more control over salary progression by requiring salary increases either solely at the discretion of the employer or upon meeting very objective criteria for increases that are set by the employer. Two problems can occur: blue-circle rates and red-circle rates--
blue-circle rates, or dots representing employees paid below the minimums just established, and red-circle rates, or dots showing employees paid above the maximum. Blue-circle rates are easy to deal with; over a period of time, the employee’s pay is raised to the point where it equals the position in the rate range that corresponds to the employee’s actual performance.
Red-circle rates are another story. Obviously, cutting the pay of an employee will not do much to gain acceptance for the new wage program, so alternatives have to be considered. One is to “grandfather” the employee; this means allowing the employee to stay above the maximum until the person is promoted, terminated, or retired. Another approach is to freeze the employee at that red-circle rate until adjustments to the rate range finally capture the employee’s rate back into the structure. Still another approach is to increase the employee’s wage by only half of the adjustments made to the range, again, until the rate is captured.
A similar problem occurs with employees who are under- or overpaid in relation to actual performance. As defined, the minimum, midpoint, and maximum rates are each definitions of pay for specific levels of performance. So an employee performing 80 percent of the job duties at 80 percent efficiency under normal supervision and who is paid above the midpoint may have a pay rate similar to a red-circle rate except that it is within the rate range. In this case, counseling and performance evaluation feedback are needed to bring performance in line with pay.
To operate effectively, the compensation program must maintain the correct classification of employees through regular review of the various classifications. Each employee is assigned to a particular job with its corresponding job description, labor grade assignment, and rate range. This is a normal outgrowth of the job analysis process. Duties, assignments, and responsibilities change, however, which can result in either wage overpayments or underpayments. It is therefore advisable to periodically review job classifications. One way to avoid improper payment is for a designated compensation administrator to review every employee hire, promotion, demotion, and transfer for correct classification.
Exempt, nonexempt. Each job (and each employee performing that job) must be classified as "exempt” or “nonexempt." This has to do with whether the job is exempt from the provisions of the Fair Labor Standards Act (FLSA) and other statutes that require payment of overtime.
Full time, part time. Part-time workers are often treated differently from full-time employees when it comes to wages and benefits. The number of hours one must work to be considered full-time is a matter of employer policy.
Temporary employees. Temporary workers sometimes receive less compensation or limited benefits. Temporary workers provided by an agency are employees of the agency, not the firm that uses their services, and therefore need not be paid in accordance with the company compensation plan.
Present incumbent-only positions. An employer may create a position designed for the skills of a particular employee or for a particular task. These jobs do not fit into the employer's permanent organizational structure and are eliminated when the employee leaves the company.
Several approaches are commonly used for determining salary increases. The most common is performance/merit systems. Across-the-board or general increases are often tied to increases in the cost-of-living index. For unionized employees, the collective bargaining agreement will include a negotiated provision for wage increases that usually includes a fixed general annual increase that may be combined in some instances with merit provisions and cost-of-living escalators that add to the across-the-board increase when the cost-of-living index goes up more than a predetermined amount.
Employee evaluation involves determining where each worker should be paid within the rate range for the job. At the beginning of the year, management sets the percentages so that they will match the overall pay budget increase. Many employers utilize a grid system with low, middle, and high ranges to determine what an employee's wage should be based on job performance and current salary. Percentages for salary increase, when warranted, can be found by matching up the two coordinates. Employees currently paid at the lower end of the range might expect a greater percentage raise than employees at the higher end, as the following chart shows:
Minimum MidpointMaximum
$25,000--28,000$28,100--32,000 $32,100--36,000
High performance (Top 20%)7%6%5%
Middle (Middle 70%)5%4%3%
Low (Bottom 10%)3%3% 2%
When their performance is reviewed, most employees want to know: “How much of a raise am I getting?” While job performance is a major factor in any pay raise decision, other factors may be considered as well:
• The employer's overall financial situation
• The department's or division's “budget” for raises
• The employee's length of service
• The employee's qualifications (i.e., the scarcity of certain talents in the labor market and the likelihood that the employee will be paid more for them elsewhere)
• How much other employers in the local area are paying for similar jobs
• What the employee requires in the way of incentives
• General economic conditions--the inflation rate, changes in the cost of living, etc.
Cost of living. Increases in the cost of living should be a major consideration when deciding on a budget for pay raises. The primary tool for measuring the cost of living is the Consumer Price Index (CPI), which is issued each month by the U.S. Bureau of Labor Statistics. Some organizations have an “escalator plan,” which grants employees across-the-board increases in proportion to increases in the CPI.
Local rates. Wage increases during the past 20 years have varied greatly among geographic areas and job categories. Employers sometimes look to wage surveys of similar organizations within their labor market area for guidance in setting or adjusting wage rates. Most employers use “pay budget” surveys rather than compensation surveys when comparing their annual increases to other employers.
Promotion/demotion/transfer. A promotion occurs when an employee goes to a higher grade job, usually with an increase in pay. A demotion is a change to a lower grade job and may carry a pay decrease, but need not do so, depending on employer policy and the particular circumstance. A transfer occurs when both jobs are in the same grade. It's not unusual to transfer workers from one job to another in the same grade with no pay change.
A “longevity increase” is a special pay raise awarded to employees whose pay has been frozen because they are at the top of their pay bracket. Companies that give longevity raises sometimes stipulate that the employee is eligible for only two or three increases of this type during the entire term of the employment.
"Red-circled" rates. If a longevity increase puts an employee's pay rate over the maximum for the pay grade, the rate is referred to as “red-circled.” Red-circled rate employees are normally not eligible to receive across-the-board, merit, or cost-of-living raises until the top limit for their pay grade becomes higher than their rate of pay.
Bonuses. Long-service employees with good records who have been ineligible for wage increases because they have reached the top of their rate ranges may also be rewarded with bonuses. This practice provides employees with an incentive, but does not create red-circled rates. Furthermore, unlike increases in base pay, a bonus is not locked in--it doesn't have to be given year after year. Because it's discretionary on the part of management, it may be given only when the employee's performance warrants it. Please see the national Bonus Payments section.
Benefits. Long-service, high-performing employees may also be rewarded with better benefits. It may be possible to provide top employees with additional vacation, personal leave time, or some other attractive benefit. This also has the advantage of not creating red-circled rates, and it does not have to be locked in--it can be modified yearly.
Comment. When inflation is low or when compensation brackets are not adjusted regularly, longevity increases help keep the compensation system in order. If such an option is not available, supervisors may artificially upgrade jobs to get pay increases for good workers who have been locked in at the maximum for their grade, and this can distort the company's organizational structure. Longevity increases, bonuses, or enhanced benefits are options that can take the pressure off the pay program in such circumstances.
It is occasionally left to the compensation manager to devise a compensation package for a high-level executive. It’s an altogether different exercise from the routine pay decisions made for other salaried and hourly people. The main objective is not to match market rates but, rather, to discover ways to tie pay to bottom-line tallies. Targeted bonuses and commissions are common and are usually linked both to the attainment of short-term objectives and to the achievement of milestones along the path to long-term goals. These incentives may often add up to an amount that is many times base pay.
Executive pay does not always come in the form of cash. Stock and stock options are one popular alternative to money, not only because they cost the corporation relatively little, but also because their value increases as company performance improves. Deferred compensation plans are also common for very highly paid people. By postponing receipt of the income until a day when they are likely to occupy a lower tax bracket, they realize substantial tax savings. It will sometimes be the executive’s own lawyer who devises the various tax-sheltering aspects of the compensation plan. It will only rarely be the compensation manager.
The most sophisticated executive pay plans are the fruit of negotiations between the executive and one or more higher-ranking officials. Like contracts with movie stars and professional athletes, executive pay packages represent an effort to estimate the dollar value of the contract to the employer and remunerate accordingly, usually with the greater part of the compensation made contingent on whether the expected dollars are finally earned. These arrangements are highly individualized and have little or no connection to labor market conditions or pay scales.
The Conference Board has published a list of recommendations for executive compensation practices, saying public companies should take immediate action to restore credibility and trust in their pay practices. The board's Task Force developed the following five guiding principles for executive compensation:
• Compensation programs should be designed to drive a company's business strategy and objectives and create shareholder value, consistent with an acceptable risk profile and through legal and ethical means. To that end, a significant portion of pay should be incentive compensation, with payouts demonstrably tied to performance and paid only when performance can be reasonably assessed.
• Total compensation should be attractive to executives, affordable for the company, proportional to the executive's contribution, and fair to shareholders and employees, while providing payouts that are clearly aligned with actual performance.
• Companies should avoid controversial pay practices, unless special justification is present. Eliminate controversial compensation practices that conflict with the notions of fairness and pay for performance--such as excessive golden parachutes, overly generous severance arrangements, gross-ups of parachute payments or perquisites, and golden coffins
• Compensation committees have a critical role in restoring trust in the executive compensation setting process and should demonstrate credible oversight of executive compensation. To effectively fulfill this role, compensation committees should be independent, experienced, and knowledgeable about the company's business.
• Compensation programs should be transparent, understandable, and effectively communicated to shareholders. When questions arise, boards and shareholders should have meaningful dialogue about executive compensation.
Last reviewed on June 16, 2014.
Related Topics:
National
What is a compensation administration program? A formal compensation administration program is the basic management tool for ensuring that employees are satisfied, that both internal and external equity are maintained, and that control is maintained over compensation costs. Such a program will help attract top talent, retain core employees, and encourage longevity while efficiently using financial resources. Establishing an effective compensation administration program requires job analysis, job evaluation, and job pricing. Once established, it is important to maintain and update the following aspects of the program: salary banding, employee classification, salary increases, performance appraisals, and longevity increases.
Each job in the organization should be thoroughly analyzed and described. Your job description should state clearly and simply:
• Who does the work (including the qualifications, education, and job skills required)
• What the work entails
• Where the work is performed
• When the work is done (hours, how often, or what times of year)
• Why the person does the work (why is the job essential to the company)
• How the job is accomplished
For the purposes of the Americans with Disabilities Act, it is appropriate and necessary to list the essential and nonessential functions of the job in case someone asks for a job accommodation for a covered disability.
Here are five job description summaries in the engineering series, for discussion purposes:
Job Title Job Description
Junior Engineer Performs routine engineering tasks using standard procedures. Applies limited judgment under direct supervision.
Engineer B Designs and develops major engineering project systems and subsystems under general supervision. May give technical supervision to lower-level engineers and technicians.
Senior Engineer ADesigns and develops portions of major engineering projects under general supervision. Provides technical support to other departments. May supervise technicians and lower level engineers.
Project EngineerDirects an engineering design team to complete assigned engineering projects in accordance with customer specifications and within schedule and budget limitations.
Director of EngineeringReports to chief operating officer. Directs the accomplishment of product engineering objectives. Provides technical guidance and ensures sound engineering procedures and effective use of facilities.
Employers should note that a job title alone is insufficient to establish the exempt status of an employee. Instead, the status of an employee must be determined on the basis of whether the employee's salary and duties meet the requirements of the regulations. If your company has not updated its job descriptions in over a year, it is possible that the actual work performed by employees under your current job titles has changed. Therefore, you may want to confer with managers, supervisors, and the employees when updating job descriptions. Once you have job descriptions that you believe accurately reflect the jobs performed, have your legal advisor review them, and sign and date the review so that you can prove your job descriptions are up to date and determine when a new review is necessary.
Job evaluation determines what jobs are worth on an absolute basis and relative to other jobs in the organization. It can be done in a variety of ways, but usually involves assigning “points” based on complexity, impact, budget, supervisory duties, and so on, and attaching job ranks based on the total number of points. Jobs that are of greater value to the organization have a higher labor grade; jobs of lesser value fill the lower grades. The five engineering jobs might be evaluated as follows:
Job Title Labor Grade
Junior Engineer 33
Engineer B37
Senior Engineer A39
Project Engineer40
Director of Engineering43
What an employer has as a result of the job evaluation program is a hierarchy of jobs based on point values (or some other set of reliable criteria.) In other words, an employer can be assured of internal equity when it comes to matching up the various evaluation "scores" with actual wage levels because all of the jobs in the organization have been compared with each other and have been evaluated accordingly. But internal equity alone can't guarantee employee satisfaction or protect a firm from a legal challenge. An employer must be aware of what other firms in the area or industry are paying for similar jobs. Once this information has been obtained and an employer has determined that the wage and salary structure compares favorably, an employer has achieved external equity as well.
Job pricing involves establishing rate ranges; that is, minimum, midpoint, and maximum dollar values for each labor grade. By studying wage and salary surveys, employers can compare wages in the labor market to the jobs within their organization. The result is a scale of wages that allows the employer to compete in the labor market (external equity) while ensuring that jobs that are worth more to the organization are paid more than those of lesser worth (internal equity). Here's an illustration of a set of rate ranges.
Labor GradeMinimumMidpointMaximum
33$30,147$40,196$50,245
37$40,954$54,605$68,257
39$52,851$66,828$81,455
40$51,533$68,711$85,888
43$64,845$86,460$108,075
In an effort to simplify salary administration, to encourage employees to acquire new skills, and to promote lateral movement within the organization, many employers have developed and implemented salary banding programs. A salary banding system involves grouping multiple, related jobs into large, expansive salary bands. For example, a company may collect all existing secretarial, administrative assistants, and clerical grades into one large salary band titled “Administrative,” with a salary band of $9.26 per hour to $24.61 per hour. Salary movement is then primarily determined by the acquisition of new skills or merit increases, because promotions do not occur within the band because an individual has been switched from one arbitrary title to another. Banding provides more control over salary progression by requiring salary increases either solely at the discretion of the employer or upon meeting very objective criteria for increases that are set by the employer. Two problems can occur: blue-circle rates and red-circle rates--
blue-circle rates, or dots representing employees paid below the minimums just established, and red-circle rates, or dots showing employees paid above the maximum. Blue-circle rates are easy to deal with; over a period of time, the employee’s pay is raised to the point where it equals the position in the rate range that corresponds to the employee’s actual performance.
Red-circle rates are another story. Obviously, cutting the pay of an employee will not do much to gain acceptance for the new wage program, so alternatives have to be considered. One is to “grandfather” the employee; this means allowing the employee to stay above the maximum until the person is promoted, terminated, or retired. Another approach is to freeze the employee at that red-circle rate until adjustments to the rate range finally capture the employee’s rate back into the structure. Still another approach is to increase the employee’s wage by only half of the adjustments made to the range, again, until the rate is captured.
A similar problem occurs with employees who are under- or overpaid in relation to actual performance. As defined, the minimum, midpoint, and maximum rates are each definitions of pay for specific levels of performance. So an employee performing 80 percent of the job duties at 80 percent efficiency under normal supervision and who is paid above the midpoint may have a pay rate similar to a red-circle rate except that it is within the rate range. In this case, counseling and performance evaluation feedback are needed to bring performance in line with pay.
To operate effectively, the compensation program must maintain the correct classification of employees through regular review of the various classifications. Each employee is assigned to a particular job with its corresponding job description, labor grade assignment, and rate range. This is a normal outgrowth of the job analysis process. Duties, assignments, and responsibilities change, however, which can result in either wage overpayments or underpayments. It is therefore advisable to periodically review job classifications. One way to avoid improper payment is for a designated compensation administrator to review every employee hire, promotion, demotion, and transfer for correct classification.
Exempt, nonexempt. Each job (and each employee performing that job) must be classified as "exempt” or “nonexempt." This has to do with whether the job is exempt from the provisions of the Fair Labor Standards Act (FLSA) and other statutes that require payment of overtime.
Full time, part time. Part-time workers are often treated differently from full-time employees when it comes to wages and benefits. The number of hours one must work to be considered full-time is a matter of employer policy.
Temporary employees. Temporary workers sometimes receive less compensation or limited benefits. Temporary workers provided by an agency are employees of the agency, not the firm that uses their services, and therefore need not be paid in accordance with the company compensation plan.
Present incumbent-only positions. An employer may create a position designed for the skills of a particular employee or for a particular task. These jobs do not fit into the employer's permanent organizational structure and are eliminated when the employee leaves the company.
Several approaches are commonly used for determining salary increases. The most common is performance/merit systems. Across-the-board or general increases are often tied to increases in the cost-of-living index. For unionized employees, the collective bargaining agreement will include a negotiated provision for wage increases that usually includes a fixed general annual increase that may be combined in some instances with merit provisions and cost-of-living escalators that add to the across-the-board increase when the cost-of-living index goes up more than a predetermined amount.
Employee evaluation involves determining where each worker should be paid within the rate range for the job. At the beginning of the year, management sets the percentages so that they will match the overall pay budget increase. Many employers utilize a grid system with low, middle, and high ranges to determine what an employee's wage should be based on job performance and current salary. Percentages for salary increase, when warranted, can be found by matching up the two coordinates. Employees currently paid at the lower end of the range might expect a greater percentage raise than employees at the higher end, as the following chart shows:
Minimum MidpointMaximum
$25,000--28,000$28,100--32,000 $32,100--36,000
High performance (Top 20%)7%6%5%
Middle (Middle 70%)5%4%3%
Low (Bottom 10%)3%3% 2%
When their performance is reviewed, most employees want to know: “How much of a raise am I getting?” While job performance is a major factor in any pay raise decision, other factors may be considered as well:
• The employer's overall financial situation
• The department's or division's “budget” for raises
• The employee's length of service
• The employee's qualifications (i.e., the scarcity of certain talents in the labor market and the likelihood that the employee will be paid more for them elsewhere)
• How much other employers in the local area are paying for similar jobs
• What the employee requires in the way of incentives
• General economic conditions--the inflation rate, changes in the cost of living, etc.
Cost of living. Increases in the cost of living should be a major consideration when deciding on a budget for pay raises. The primary tool for measuring the cost of living is the Consumer Price Index (CPI), which is issued each month by the U.S. Bureau of Labor Statistics. Some organizations have an “escalator plan,” which grants employees across-the-board increases in proportion to increases in the CPI.
Local rates. Wage increases during the past 20 years have varied greatly among geographic areas and job categories. Employers sometimes look to wage surveys of similar organizations within their labor market area for guidance in setting or adjusting wage rates. Most employers use “pay budget” surveys rather than compensation surveys when comparing their annual increases to other employers.
Promotion/demotion/transfer. A promotion occurs when an employee goes to a higher grade job, usually with an increase in pay. A demotion is a change to a lower grade job and may carry a pay decrease, but need not do so, depending on employer policy and the particular circumstance. A transfer occurs when both jobs are in the same grade. It's not unusual to transfer workers from one job to another in the same grade with no pay change.
A “longevity increase” is a special pay raise awarded to employees whose pay has been frozen because they are at the top of their pay bracket. Companies that give longevity raises sometimes stipulate that the employee is eligible for only two or three increases of this type during the entire term of the employment.
"Red-circled" rates. If a longevity increase puts an employee's pay rate over the maximum for the pay grade, the rate is referred to as “red-circled.” Red-circled rate employees are normally not eligible to receive across-the-board, merit, or cost-of-living raises until the top limit for their pay grade becomes higher than their rate of pay.
Bonuses. Long-service employees with good records who have been ineligible for wage increases because they have reached the top of their rate ranges may also be rewarded with bonuses. This practice provides employees with an incentive, but does not create red-circled rates. Furthermore, unlike increases in base pay, a bonus is not locked in--it doesn't have to be given year after year. Because it's discretionary on the part of management, it may be given only when the employee's performance warrants it. Please see the national Bonus Payments section.
Benefits. Long-service, high-performing employees may also be rewarded with better benefits. It may be possible to provide top employees with additional vacation, personal leave time, or some other attractive benefit. This also has the advantage of not creating red-circled rates, and it does not have to be locked in--it can be modified yearly.
Comment. When inflation is low or when compensation brackets are not adjusted regularly, longevity increases help keep the compensation system in order. If such an option is not available, supervisors may artificially upgrade jobs to get pay increases for good workers who have been locked in at the maximum for their grade, and this can distort the company's organizational structure. Longevity increases, bonuses, or enhanced benefits are options that can take the pressure off the pay program in such circumstances.
It is occasionally left to the compensation manager to devise a compensation package for a high-level executive. It’s an altogether different exercise from the routine pay decisions made for other salaried and hourly people. The main objective is not to match market rates but, rather, to discover ways to tie pay to bottom-line tallies. Targeted bonuses and commissions are common and are usually linked both to the attainment of short-term objectives and to the achievement of milestones along the path to long-term goals. These incentives may often add up to an amount that is many times base pay.
Executive pay does not always come in the form of cash. Stock and stock options are one popular alternative to money, not only because they cost the corporation relatively little, but also because their value increases as company performance improves. Deferred compensation plans are also common for very highly paid people. By postponing receipt of the income until a day when they are likely to occupy a lower tax bracket, they realize substantial tax savings. It will sometimes be the executive’s own lawyer who devises the various tax-sheltering aspects of the compensation plan. It will only rarely be the compensation manager.
The most sophisticated executive pay plans are the fruit of negotiations between the executive and one or more higher-ranking officials. Like contracts with movie stars and professional athletes, executive pay packages represent an effort to estimate the dollar value of the contract to the employer and remunerate accordingly, usually with the greater part of the compensation made contingent on whether the expected dollars are finally earned. These arrangements are highly individualized and have little or no connection to labor market conditions or pay scales.
The Conference Board has published a list of recommendations for executive compensation practices, saying public companies should take immediate action to restore credibility and trust in their pay practices. The board's Task Force developed the following five guiding principles for executive compensation:
• Compensation programs should be designed to drive a company's business strategy and objectives and create shareholder value, consistent with an acceptable risk profile and through legal and ethical means. To that end, a significant portion of pay should be incentive compensation, with payouts demonstrably tied to performance and paid only when performance can be reasonably assessed.
• Total compensation should be attractive to executives, affordable for the company, proportional to the executive's contribution, and fair to shareholders and employees, while providing payouts that are clearly aligned with actual performance.
• Companies should avoid controversial pay practices, unless special justification is present. Eliminate controversial compensation practices that conflict with the notions of fairness and pay for performance--such as excessive golden parachutes, overly generous severance arrangements, gross-ups of parachute payments or perquisites, and golden coffins
• Compensation committees have a critical role in restoring trust in the executive compensation setting process and should demonstrate credible oversight of executive compensation. To effectively fulfill this role, compensation committees should be independent, experienced, and knowledgeable about the company's business.
• Compensation programs should be transparent, understandable, and effectively communicated to shareholders. When questions arise, boards and shareholders should have meaningful dialogue about executive compensation.
Last reviewed on June 16, 2014.
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