Changing Face of Exec. Pay: Case History

Performance Performance Unit plans are gaining traction in industries ranging from manufacturing to service and from dot.com to retail. Boards and stockholders like this plan because it creates a dynamic tension between achieving short-term results and long-term outcomes. Participants are required to understand the business, maximize the ROI of available resources, think strategically and act tactically. Exceptional performance delivers exceptional wealth. Average performance may result in minimal deferred compensation, if any.

Owners of closely held companies like this plan because it is a low risk approach that enables them to compete for the best talent in the marketplace. And, it provides the foundation of an exit strategy.

A modified version of this plan was developed for a client in the manufacturing sector. The privately held company needed a top notch marketing executive to capture the marketplace growth potential. The owner’s exit strategy was to sell the company in seven years. To that end, he was committed to maximizing the value of the company in terms of EBITDA and market multiplier. The marketing executive was an essential element in this plan.

The challenge was to develop a pay package that would attract someone at the top of their game to a small Midwestern city, for a private company that would be sold in the near future.

The solution was to offer a pay package that matched the business opportunity. A combination of base and incentive pay was set at the 85th percentile of the market. The deferred incentive compensation element was designed to reward the increase in asset value. By using a modified Performance Unit design it was possible to share the increase in value without changing the company’s capital structure.

In this design, units are earned annually and represent a right against ownership (RAO™). Unlike traditional performance units, RAOs are not cash equivalents. Instead, they represent a percent of the market value. The design encourages the leadership team to improve net profit, reduce debt and polish up the company’s market appeal to increase the value modifier at time of sale.

Compensation is an evolving discipline. Stock options have shown us there is no free lunch when it comes to pay. Compensation is a cost. But it is also an investment and we are now at the point where compensation professionals are beginning to emphasize pay systems that reward Return on Investment.