Let´s face it-being an executive compensation planner was easy for some years now. Stock was king and it was delivered in generous portions. Companies implemented incentives based on popular measures of company success. And it worked. Executive pay rose substantially with company performance. Shareholders were generally satisfied. Although the business press continued to sensationalize executive pay, they had to search a bit harder in the company haystack for CEO´s who were paid at an unruly level compared to company financial outcomes.

It´s time to look at reward tools that worked beautifully for nearly a decade. Stock and stock-related rewards dominated. Prevailing practice and "best" practice were synchronized. All you did was adopt what most "companies like yours" do. It all worked. Who´s to argue if your executive compensation practices are "lifted" from a globally admired company or two?

History & History Repeating?

The last few years made executive compensation a "growth business". Pay grew in the absolute sense. Sometimes in concert with company performance but often not. Here´s a brief overview of recent "history":

• Total executive pay was comprised mostly of stock options supplemented by moderate annual incentive opportunities and base pay. Up went company stock and up went executive compensation.

   

• Executives negotiated for more options and less of everything else. And they got options in mega-grants, as hiring bonuses, and as buy-outs of former employer option and even retirement plans.

   

• Some got direct stock awards and restricted stock with only time restrictions. These "gifts" could only be defined as "rewards for performance" by the totally uninformed.

   

• Cash incentives were based on ever-improving earnings and capital return formulas. Each year´s financial projections were better than the last. Growing to greatness beCAMe the byword and it was realized year after year.

During the last few business downturns, most companies moved from stock and performance incentives to more base pay and restricted stock with only time restrictions. Rewarding officer performance was largely abandoned. The mix of compensation changed from incentives to more guaranteed pay. Many liberal executive benefit packages and supplemental retirement plans came into being. Is that the direction executive compensation will follow this time around? Perhaps it is in terms of prevailing practice.

Once More Into the Breach?

In 2000 some companies begun to solidify some fairly arcane executive compensation practice. More guaranteed cash. Short-term incentives based on levels of earnings performance that would have made the most pessimistic of financial executives scoff-never in this company. What´s the current "buzz" in the press for the half-year just ended?:

• Some companies are moving to pay solutions that escape correlation with company performance. The shift to semi-guaranteed payoffs is selectively occurring. This means that either the compensation vehicle is not related to performance, or if performance is a factor, thresholds are not at all challengingly set.

   

• Restricted stock is often the "tool of preference". That´s restricted stock with only time restrictions. Sometimes isn´t just a stock grant that bypasses any concept of incentives at all. Not performance restrictions as well. It´s a "gift" and not granted to encourage or reward performance. This is a major difference we will return too soon.

   

• Cash compensation is increasing. Base pay is creeping up again. Not at a high gallop yet, but at a reasonable "lope". Executive base pay budgets are beginning to increase to partially make up for the loss in momentum for executive compensation delivered by financial metric inflation.

   

• Repricing options is re-starting. Slowly and perhaps with maybe a different "name". This means changing the price at which executives can exercise existing stock options. The goal is a stock price no higher than the current market value of their company´s common stock. Alternatives exist and we will talk about them in a bit.

   

• Moving to "other" compensation forms that needn´t be specifically identified in public reports. The "others" vary from retirement supplements and fairly assured types of payment. These "make up" for the gap between executive pay expectations and what performance-based compensation solutions deliver.

Changing For the Best

Your company can be different. It´s not that difficult. You needn´t vary much from prevailing practice. It´s more how the pieces are assembled than the use of different tools of the trade. That´s because we have some economic re-momentum building. It may leverage executive rewards. While the same analysts that predicted "the boom will run on and on" are still our predictors going forward. But, just the reality of economic cycles could help.

Think about it. We have a steep economic slump combined with the loss of workforce productivity and effectiveness. Stock prices well off what they were just a year ago and earnings projections missed and missed again. Pretty bad news. Eventually, analysts will get it right-by accident. Not because they´re good. But what goes down eventually goes up again. And when they do stumble on the right performance formula, hold onto the reigns. This horse called US business may really rebound.

Let´s get executive compensation solutions aligned so rewards can help get your strategy set for the "roar back". Let´s tune it now so your leadership team shares in the pending success of your enterprise. Here are some things that need doing. Some are issues for your leadership team. Others need board approval.

Getting Compensation Set to Sail

It takes time to put well-conceived executive compensation solutions in place. This isn´t the time to blow a golden opportunity. Before we´re in good times again, it´s important to have the reward solution in place. Otherwise, you get criticized as a "good time Charlie". That means putting in rewards once the good times are on the way again.

Your board´s HR committee should be in the loop. Time to show them what´s working in executive compensation for your company and what´s not. Discuss performance metrics in light of how shareholders are faring. Many boards hear much about how an executive team will measure performance when performance is solid. The silence about measurement is often deafening when what has always gone up does a course correction in the wrong way.

Look at your executive compensation strategy. See how it fares when business times aren´t so good. Your company may not have a strategy at all. Or it may have one that provides your board with some yardsticks with which to monitor alignment of executive compensation. A strategy for executive rewards shouldn´t be a fair weather friend-it shouldn´t just share the upside. It needs to address issues of focus and talent retention when things are going in a way the board would not like to see them go.

Omnibus Incentive Plan

The secret sauce of executive pay, in our minds, is long-term incentives. The focus on the future can be stock or cash-based, and reward sustained financial and strategic performance results. So, our focus is on long-term incentives. For long-term incentives, we like flexibility. You need to be adaptable and leave your reward application alternatives open. The only way to do that is to get the reward basics approved by your board so they know what you are going to do and sponsor it. But you can´t keep going back for more and more.

This solution provides adaptability to match the executive compensation long-range incentive tool to the specific situation. It takes time to get approval from the board for a new long-term incentive direction. Some say this is appropriate because it gives control to the shareholders. It makes sense for the shareholders, through. They can see performance measures and the logic of "threshold" and "target"performance. They see the advantage of certain tools from the omnibus plans than others for a specific application. They see the value of some alternative projections in terms of what one alternative solution may generate as an alternative to another.

The list you use really depends on the company and situation. Here´s our laundry list of possible tools. You should include them in your long-term incentive armament:

• Stock options with performance accelerated vesting

   

• Restricted stock with performance restrictions

   

• Long-term "cash" incentives with cash/stock payouts

   

• Officer stock retention guidelines.

Options with performance accelerated vesting

Most options vest as a result of the passage of time. With the focus companies have on performance during challenging times, it may be time to add some performance hurdles in addition to time for option vesting. Permitting optionees the chance to exercise options sooner rather than later if certain goals are met, is a possible win for both the company and the optionee.

If normal options vest on a timetable of a third, a third, and a third, over some reasonable time. Performance accelerated options permit perhaps the second third to be exercised sooner art her than later. The plus for the company is that some key internal measures and the board is most often willing to permit a larger option grant to the recipient and even tolerate some additional overhang and potential stock dilution by offering more options rather than fewer. It´s an excellent chance for a company to provide some substantial upside stock ownership opportunity starting in 2002 without the negatives of repricing existing options.

It is also an excellent time to gain a new focus on key measures of company performance. New priorities of earnings re-growth, new market share, cash flow improvement, and perhaps other key strategic measures. It places new emphasis on needed directions and encourages a renewed interest in new options that are on the table rather than reminiscing about what´s over the dam for now, anyway.

Restricted stock with performance restrictions

The moniker "restricted" is really a misnomer for most of these types of long-term rewards. A better name would be "time-based guaranteed stock grants". All the officer needs to do is put in the time and the stock, at whatever price it happens to be, passes to the employee from the company. For example, if the executive gets a restricted stock grant of 15,000 shares with 1/3 vesting after two years, another 1/3 in three years, and the last 1/3 in five years, when the time passes the stock becomes the property of the employee. If the stock drops from $100.00 per share to $50.00 per share during the time, it is a problem only because the value of the shares received is less. The executive still gets the "free" shares at whatever price.

Now if the company adds performance restrictions, that´s a different story. This requires that a combination of time and performance hurdles be reached. Since stock grants have value no matter what the price of stock at the time it is passed to the executive, metrics can give something to the company in exchange for the stock grant. As with accelerated vesting of options, measures such as earnings re-growth, new market share, and cash flow improvement can be used. Obviously, stock price performance can be used as a hurdle. For example, some minimum level of stock price or appreciation can be a "trigger" for vesting the restricted stock.

The goal is a "win-win" for both the company and the officer. The officer gets the stock at a value that is important to estate building, and the "restrictions" are the proper kind for the company to have. Obviously, options are more tax effective than restricted stock to both the company and the executive. But stock price is less predictable and company priorities may be volatile and impacted by other than measures of company success in at least the shorter term. In this event, restricted stock with the right type of restrictions may be the "secret code".

Long-term "cash" incentives with cash/stock payouts

Not all long-term incentives need to emphasize company stock along the way. But a long-term cash incentive can be based on overlapping three-year performance periods and use key strategic performance measures. Of course a long-term cash plan can emphasize corporate performance as we discussed in the case of options and restricted stock. But long-term cash incentives can also be implemented where measures are mix and match-some corporate and some business unit, for example. The real power of along-term cash incentive plan is flexiblity-the solution can focus on a mix of measures and goals. It can change from three-year period to three-year period as business strategies and priorities change.

While cash does have cost considerations to the company, and tax implications to the executive, these cost and tax consequences can be taken into consideration. For example, performance expectations can be set so paying the awards, even with their cost implications, is a good deal to the company. This means the performance delivered by the executives participating in the long-term incentives is worth the cost to the company. What the balance point for proving value is subjective, the cost implications can be considered in the design.

From the standpoint of the executive, anybody who tells you they would rather not have a significant performance award even when it is taxable, is kidding you. If a cash or stock award is enough to make excellent performance economically worthwhile, paying the tax will not cause people to say, "take this back, I don´t want to pay the tax". The agility of long-term cash incentives makes them a tool to have in your kit bag for 2002.

Officer stock retention guidelines

While no evidence exists that companies where key executives are significant stockholders outperform companies where they are not, the symbolic value of executive stock ownership is significant. The investment community constantly looks to ownership as an indication of loyalty and commitment. It seems practice is that CEOs own about 5X their base salary in terms of company stock. And corporate officers several levels below the CEO will have about 2X base salary. Part of the long-term incentive strategy should be to provide a way for senior executives to get and keep stock in their company.

Future Upon Us?

We are involved in a time of change. And executive compensation, especially long-term incentives is hitting some rough seas. The time is right to look to putting some additional "juice" in your incentive designs. This means a strong focus on long-term incentives. Key leaders of top companies are mostly interested in where their company will be in the next few years. While many companies are saying "poor me" to executive compensation, the smart ones are giving strong attention to what counts the very most.

Patricia K. Zingheim and Jay R. Schuster

Pat and Jay are partners in Schuster-Zingheim and Associates, Inc., a globally recognized pay and rewards consulting firm located in Los Angeles and founded in 1985. They consult with a wide range of companies throughout the world on the development of total rewards, incentives, and other pay solutions. Pat and Jay were selected as pay and motivation gurus in The Guru Guide. They are authors of a new best-selling rewards book Pay People Right! Breakthrough Reward Strategies to Create Great Companies (Jossey-Bass, 2000) and the best all-time selling book on workforce pay, The New Pay: Linking Employee and Organizational Performance (Jossey-Bass Publishers, 1996). They are authors of over 100 articles in business magazines on the subjects of rewards and organizational effectiveness. Both are contributors to publications such as Fortune, Across the Board, Wall Street Journal, Working Woman, and Business Week. They have appeared on many television, cable, and radio programs including CNBC, CNNfn, NBC, and CBS. They speak throughout the world to leadership audiences interested in creating a high-performance workplace through people.