Executive compensation packages are now being tied to meeting established goals The fallout from the wave of executive compensation scandals over the past several years has had a permanent effect on how CEOs and other executives are compensated for their work.

The combination of stricter media and public scrutiny and the implementation of the Sarbanes-Oxley accounting reform act has led to finance committees having to justify to a company’s board of directors the compensation packages for C-level and other executives.

Sarbanes-Oxley, signed into law by President Bush in July 2002, was passed in response to the corporate and accounting scandals of Enron, Arthur Anderson and others in 2001 and 2002. The law’s purpose is to rebuild the public trust in the corporate sector. It requires that publicly traded companies adhere to new governance standards that broaden board members’ roles in overseeing financial transactions and auditing procedures.

In the wake of such scrutiny, finance committees must show their boards of directors that the compensation is appropriate and is linked to outcomes and targets, said Robert J. Cunningham, vice president of human resources and corporate services for the National Association of Manufacturers (NAM).

“It’s more than just residual — it’s reality,” Cunningham said. “The general public is saying it is fine to pay these people, but we want to know that the compensation is linked to performance.”

Rather than having a base pay and a bonus, regardless of company performance, at the end of the year, executives now are receiving base pay for duties, plus at-risk pay that is tied to specific performance criteria.

“The at-risk pay is linked to goals that are established at the beginning of the year and have metrics associated with them,” Cunningham said. “It could be for reaching certain financial targets, such as earnings per share or the stock price.”

While these reforms are required for publicly traded companies, non-public companies that are not bound by Sarbanes-Oxley are also taking a closer look at their financial and accounting practices. Many are implementing changes voluntarily.

In a recent survey of privately held businesses conducted by Menlo, Calf.-based Robert Half Management Resources, 48 percent of chief financial officers (CFOs) said they have made adjustments to their firms’ accounting processes since the onset of Sarbanes-Oxley. Respondents cited payroll/benefits as the most frequent area of change.

“Even though private businesses are not legally required to comply with regulations such as Sarbanes-Oxley, many firms are looking at their high-exposure areas with increased scrutiny,” said Paul McDonald, executive director of Robert Half Management Resources. “As a result, non-public companies are reviewing wages, salaries and bonuses, as well as medical and other employee benefits such as phantom stock options, as though they were publicly traded.”

Private firms recognize the need to make sure their accounting practices are in order, McDonald pointed out.

“Companies of all sizes are taking measures to prevent costly errors or potential fraud across all financial functions within an organization,” he said.

Like other industries, manufacturing has felt the impact of the compensation scandals.

“I think manufacturing companies are wary of enriching people without being able to justify how they are paying people to their boards of directors, the stockholders and the public,” Cunningham said.

In large manufacturing firms, the justification goes from the boardroom down to plant-level management. In small and medium-sized manufacturing firms, the justification runs from senior management to department-level managers.

“It’s going down to executives making in the upper five figures,” Cunningham said.

Manufacturers are striving to be the employer of choice to get the top talent coming out of businesses schools or from their competitors. And they are trying to craft compensation packages that include base pay; at-risk pay in the form of bonuses, incentives or stock, which is tied to measurable goals; and benefits.

“After the grading period, the compensation committee or board of directors can say you reached your goals, you didn’t reach your goals or you got part of the way there,” Cunningham said. “Based on the progress and success , an executive may receive additional renumeration.”

This trend is apparent in Executive Compensation 2003: The National Executive and Senior Management Compensation Survey, according to Cunningham. The survey analyzes national and regional data by base pay, incentive pay and total cash compensation for more than 30 selected executive and senior management positions.

Comparing Salaries

The drive for attracting the top talent and paying that talent accordingly, has led to another trend in executive compensation. It is no longer taboo for an HR person from one company to contact his or her HR colleague from another company and discuss compensation.

At one time, that information was considered proprietary and any attempt to discover it was tantamount to corporate espionage.

That stigma, however, has been lifted.

“Companies don’t freely give out confidential information but are more willing to share general information on how they compensate people,” Cunningham said.

What’s more, that type of benchmarking has become commonplace in corporate America. Surveys such as Executive Compensation and Web sites such as www.ecomponline.com provide compensation data on thousands of senior-level positions. On ecomponline.com, users can type in publicly traded companies and find compensation information for senior executives. For example, in fiscal year 2004, Steve Ballmer, CEO of Microsoft Corp., received a base bay of $591,667 and a bonus $310,000 for a total compensation package of $901,667.

Cunningham said companies want to make sure they are pricing their positions relative to the market. “Companies want to make sure they’re paying their people appropriately but not overpaying them,” he said. “They want to attract and retain the best talent to make themselves successful.”

The 2004/2005 edition of Executive Compensation and other compensation titles are available for sale at www.nambooks.com.