Executive Compensation in a Tough Economy - hr.blr.com, July 9, 2008

Your ability to adapt to a changing economy is critical, he
believes, and part of that is identifying and reacting to trends. We
asked Rayner to discuss the trends he's seeing in executive
compensation, in an effort to help readers as they ride out this
difficult economy.

Not a Lot of Movement for Executives

As is true with employees in general, Rayner doesn't see many
executives changing jobs right now. His role is often to represent the
executive in negotiating his or her move to another company, oftentimes
with large investment banks. But hiring at these firms has stagnated.
"What we're seeing right now is that investment banks and financial
institutions are not really hiring people. In fact, they're pretty much
firing a whole lot of people," he says. "Layoffs are happening much
more quietly than they have historically. This happens every time there
is a down economic cycle. There is not a lot of movement with the
investment banks; people who have jobs are pleased to still have them,
and nobody is really looking to add staff right now."

But for those who do change jobs, the picture may be
brighter, at least in one particular circumstance. In troubled
companies, those that really need to change the way they're doing
things, hiring a new chief executive may be the only way to stay in the
game. "In more difficult economic environments, such as we're in right
now," says Rayner, "there is usually some pressure on executive
compensation and what companies are willing to pay. But at the same
time, there are some amazing deals to be had because there are some
companies that are really having a lot of problems right now, and they
desperately need senior executives to fix them. So they're out
shopping, and in those particular cases, the senior executive coming in
may have a lot of negotiating clout."

Negotiating at the Top: In-House vs. Outside Counsel

Rayner says that in his role representing an executive who is
negotiating an employment contract, he is sometimes hammering out the
details with another attorney representing the company. Other times, he
is facing a representative of HR. Why would the executive need an
attorney? "Frankly, (an attorney's) perspectives are somewhat different
from a client's," he says. "The client isn't necessarily focused on the
legal terms of the contract. They're not focused on when they can be
fired and not be paid severance. They're not focused on what the
severance should be. Everybody goes into a deal figuring everything is
going to go well. The lawyer's job is to look at everything that can go
wrong, and try to have provisions and protections for those
situations."

So considering that top level executives you're courting may
be represented by counsel, who should represent the company in the
negotiations? Rayner says that in-house staff may or may not have the
expertise required: "They don't necessarily know what the market is for
the CEO of a large, public company. Add to that the fact that they may
be reporting to the person they're trying to hire, or maybe they're two
levels down from reporting to that person. It becomes a very tricky
situation for them."

"There is a radical difference between the large financial
institutions, like investment banks, and traditional manufacturing
companies and companies in other sectors," he continues. "Investment
banks essentially have their own compensation system, and the new
executive will be brought in amongst other managing directors. They
generally have a system for how to allocate money among their group of
managing directors. With other kinds of companies, you have one CEO,
and maybe 6-10 directors that report to the CEO. It's a very different
situation. There isn't anyone else like the CEO in the company. You're
not worrying about parity, so it's a very different negotiation." Make
sure the company's interests are well-represented, Rayner suggests.

The Role of Legislation

Everyone knows that executive compensation is high, sometimes
shockingly so. Rayner points out that legislative actions are partly
responsible. By adding layers of complexity to executive pay, laws can
have results that are unexpected and unnecessary. To illustrate, he
discusses parachute payments, which are essentially severance payments
made to executives when their services are no longer necessary due to
an acquisition. "There is an excise tax levied on the executive, of 20%
of the amount of a parachute payment," he says. "Companies have
responded to this by giving executives gross-ups: they pay enough
additional money such that, after paying all taxes, the executive is in
the same place as if there was not an excise tax.

"For a senior executive, you're probably talking about an
effective tax rate of 45% in total. With a 20% excise tax, it would
amount to about 65%. The executive is now clearing 35 cents on the
dollar. If he or she gets a parachute payment and has an excise tax of
$100, the company has to give him or her an extra $300 in order to get
to $100, because 2/3 or what you're paying him or her is going to
taxes." The executive's pay is now substantially more than what it
might have been, thanks to this complication.

Another example of legislative interference is the Section
162(m) limitation on the deductibility of executive compensation. "It
essentially says that companies cannot deduct compensation in excess of
$1 million per year for any of their five most highly compensated
officers," Rayner explains. "The exception to that is 'qualified
performance-based compensation.' The biggest category of 'qualified
performance-based compensation' is stock options. Think about how the
market reacts to that. If an executive is making $1 million, and you
want to lure him or her away with $1 million, the executive is going to
say, 'I want the million dollars plus a huge number of stock options,
and those are deductible for you.' Throw in the bull market in the 80s
and 90s, and you have massive compensation payouts.

"Along with the old accounting rules, which didn't require
taking any charge for stock options, and basically its like printing
money in your basement. In the normal world, the executive would have
said, 'I'll leave this $1 million job if you'll give me $2 million.'
But now they couldn't do that, and instead used a large number of stock
options. So you throw these things together, and the result has been
executives who are fabulously wealthy."
As you think about your compensation plans, ask yourself these
questions:

1. Are all of your compensation plans, including those for executives, light on their feet, and ready to change when required?
   


2. Are you taking the time and effort to review your compensation plans in light of business and economic changes?
   

If change truly is the only constant, then the economic pendulum
will eventually swing back toward prosperity. Your answers to these
questions can help or hurt your business, and may be the difference
between success and failure.