Executive compensation is far more than a paycheck; it reflects a company’s values, its long-term strategy, and its governance culture, and in this way, can affect the legal, financial, and operational domains within an organization. With increasing regulatory scrutiny and rising expectations from shareholders, companies must design compensation frameworks that are competitive, compliant, and aligned with sustainable performance.
The Components of Executive Compensation
A strong executive compensation framework blends fixed pay, performance incentives, equity, and supplemental benefits to create a package that supports organizational goals.
Base salary and annual bonuses remain the foundation of executive compensation packages, offering stability and rewarding near-term achievements. However, cash alone cannot create long-term alignment. Companies, therefore, rely heavily on performance-based and equity incentives to reinforce sustainable results.
Equity Compensation
Equity remains one of the most influential tools for driving executive behavior. Equity awards take many forms, including restricted stock, stock options, stock appreciation rights (SARs), and ‘phantom equity.’ These instruments place executives in a position where their financial outcomes correspond with shareholder value. Elizabeth Richert of Much Shelist, P.C., points out that there is a growing shift in compensation plan structure that conditions equity on performance rather than simply time.
Deferred Compensation
Deferred compensation plans allow executives to shift income to a later time, typically at separation or retirement. However, these arrangements must comply with IRS §409A regulations.
“409A is very broad, very strictly enforced,” warns Andrea Powers of Donelson, Bearman, Caldwell, & Berkowitz, PC. “Even administrative mistakes can trigger substantial penalties, including immediate taxation.”
Perks and Supplemental Benefits
Contemporary executive benefits may include relocation reimbursement, commuter allowances, supplemental disability insurance, executive health programs, and enhanced retirement benefits. While less flamboyant than the perks of earlier decades, these benefits continue to influence recruiting and retention efforts.
Pay for Performance
Choosing the Right Metrics
‘Pay for performance’ remains the norm, but selecting the proper metrics by which to measure performance is critical.
Common financial metrics include revenue growth, EBITDA, earnings per share, cash flow, and total shareholder return. Each metric will have its own limitations, of course, and so it is important to use a diverse set of metrics. For instance, market swings often distort total shareholder return, making it an imperfect standalone measure. And as Daniel Cotter of Aronberg Goldgehn observes, only a small percentage of the stock price can be attributed to management’s actions in a given year.
Non-financial metrics include innovation and product development, customer satisfaction and retention, employee culture and turnover, compliance and safety, and ESG-related performance.
Most experts recommend using five to ten metrics with a mix of short-, medium-, and long-term targets. This avoids overweighting any single factor and encourages balanced performance.
Benchmarking
Benchmarking executive pay against relevant organizations helps maintain competitiveness.
Here, Neil Lappley of Lappley & Associates, Ltd. stresses the importance of choosing appropriate peers: “You need to sort out what makes sense in terms of competitors in size and geography.”
Peer groups are typically selected based on:
- Industry sector
- Revenue range
- Geographic scope
- Talent-market competition
Compensation committees play an essential role in designing and administering executive pay and rely on these comparisons to ensure pay is reasonable and aligned with market standards.
Their responsibilities include:
- Hiring and supervising compensation consultants
- Selecting performance metrics and plan structures
- Evaluating risk created by compensation plans
- Overseeing proxy disclosures
- Ensuring legal and regulatory compliance
Committees must also keep shareholder perceptions in mind as executive compensation remains a frequent target of shareholder activists seeking governance changes.
The Regulatory and Legal Landscape
Securities law, tax regulations, and exchange rules form the backbone of compensation governance.
Securities Law
The Sarbanes-Oxley Act imposes significant restrictions, including:
- A ban on most executive loans
- Accelerated reporting of insider trades
- Enhanced disclosure and internal control obligations
These measures curtailed compensation practices that once contributed to perceived inequities or abuses.
The Dodd-Frank Act remains one of the most significant compensation-related laws. Its key provisions include:
- ‘Say-on-Pay’ shareholder votes
- Disclosure of the CEO-to-median-employee pay ratio
- Mandatory clawback requirements
- Independence standards for compensation committees
- Detailed pay-for-performance disclosures
Tax Regulations
Tax law greatly shapes compensation strategy. Noncompliance can result in immediate income inclusion, excise taxes, and reputational damage. Relevant tax code regulations include:
- 83: Property transferred in connection with performance of services
- 162(m): Deduction limits on executive pay
- 409A: Deferred compensation
- 457: Deferred compensation for tax-exempt organizations
Stock Exchange Regulations
NYSE and NASDAQ require compensation committees to maintain strict independence, evaluate consultant independence, and approve equity plans transparently. Even private companies often emulate these standards to strengthen governance and prepare for potential public offerings.
Differences Across Employer Types
Public Companies: Public companies face the greatest scrutiny due to SEC reporting obligations, ‘Say-on-Pay’ votes, and exchange requirements. Their disclosures must clearly articulate how compensation supports performance.
Private Companies: Private companies enjoy more flexibility but still must consider tax compliance, investor expectations, and competitive pressures. Negotiation between executives and owners is typically more individualized.
Nonprofit and Tax-Exempt Organizations: Tax-exempt organizations face special rules under IRS §457 regulations and private inurement laws. Board members may even face personal liability for approving excessive pay, making documentation and benchmarking essential.
Best Practices for Effective Compensation Design
Executive compensation shapes organizational performance, culture, and public perception. When designed thoughtfully, it reinforces long-term value creation, legal compliance, and shareholder confidence. In the end, compensation should motivate leaders to build long-term performance. With balanced incentives and strong governance, companies can implement compensation plans that achieve exactly that.
Best practices include:
- Aligning incentives with long-term strategic goals
- Combining financial and non-financial metrics
- Avoiding overreliance on any single metric
- Using multi-year performance cycles
- Evaluating peer groups and metrics annually
- Maintaining strict tax law compliance
- Keeping documentation clear and thorough
- Communicating expectations transparently to executives
To learn more about this topic, view Executive Compensation. The quoted remarks referenced in this article were made either during this webinar or shortly thereafter during post-webinar interviews with the panelists. Readers may also be interested in reading other articles about governance.
This article was originally published here.
©2025. DailyDACTM, LLC d/b/a/ Financial PoiseTM. This article is subject to the disclaimers found here.
