Executive Compensation: Does Reasonable Comp Live & Where?

I attended a holiday party at a law firm and between the beef and beer I was asked to recommend someone who could do an analysis of whether a company’s compensation arrangements for its executives were reasonable. This kind of question comes up in two worlds. The first is that of shareholders who are fighting with a company’s management. If the executives are being overpaid by $1 million a year that’s $1 million that could have been paid to the shareholders or $1-4 million in potential value if the business was marketed for sale. Often this gets dicey because the executives alleged to be overpaid often control the voting stock of the business and set their own compensation. The same issue arises in a divorce setting where one spouse is contending that the business is being undervalued because the executives have grossly inflated compensation arrangements. That also affects the value of the business interest when it comes time to divide the marital assets.

Executive compensation has become a swamp of elusive problems. Forty years ago, senior executives were paid a handsome salary and awarded bonuses commensurate with the financial performance of the company in the preceding year. Then stock options and stock awards got added to the mix. Bonus comp started to come in more complicated forms. Instead of or in addition to director awarded bonuses, there began to evolve long term incentive plans which adopted a payment formula based on an algorithm comparing executive compensation of the employer with “comparable” companies and then issuing awards based on the algorithm.

Confused? Let’s look at the comp arrangement of a recent matter I was involved in. The employee is chief counsel for a publicly traded company registered on NASDAQ. When he was invited to the executive suite a decade ago his salary was $300,000 and he was invited to participate in the executive incentive plans. Back then he was awarded about 25,000 options at the then prevailing price of $16 a share. He also received some restricted stock units which would offer additional value as they vested over three years. Our subject has always held corporate counsel positions since being admitted to practice law in 1996.

For 2023, the filings with the Securities and Exchange Commission reflect that his salary was $500,000 and that it has been increasing by $20,000 a year for the last few years. So, that looks like a 4% raise on average. For comparison, $500,000 is about the same compensation as fifth year associates make working in Wall Street law firms. And while their responsibilities are not small, it’s not like the pressure of being general counsel to a $3.8 billion international company with 28 years of experience.

But, wait. The salary of our general counsel is not all he earns. The officer’s compensation charts in the SEC filing go on for many pages. There was no bonus in recent years, but our counsel received stock awards in 2023 valued at $1.3 million. He was also awarded stock options that are reported as worth another $250,000. Then there is a category termed “non-equity compensation.” This circles back to that comp we said was based on a formula rather than the employer’s stock price as a cash incentive. The idea here is to make certain the executive is paid fairly if he or she meets arithmetic targets even if the stock market is not loving the company’s stock itself. The 2023 payout in this category of comp was another $230,000. Next, we move on to a category called “Changes in Pension and Non-qualified Compensation.” Our general counsel has a defined benefit pension plan in addition to a 401K retirement. When he retires, the company will pay him an annuity for life premised upon his years of service. The contribution to fund that in 2023 was just over $30,000 and was not paid to him directly but contributed to a fund for payment at retirement. The term non-qualified compensation typically takes in promises to pay future amounts but the employer does not have to set the money aside. It is a promise to pay at a future time from future revenue.

Last, we get to “All Other Compensation” which is, indeed, a catch all. Most executives have employer paid contributions to their health care and life insurance. In this case a separate chart in the SEC filing notes $30,000 in 401K matching funds and another $30,000 in funds paid to non-qualified retirement plans.

Sum all of these numbers and the position of general counsel begins with a salary of $500,000 but ends with compensation aggregating to just over $2,400,000. To be fair, the $1.55 million in stock and option value may be a bit overstated because most companies value these on a model called “Black-Scholes” which can be inflated. And, part of that complication includes the fact that the stock and options typically vest over 3 or more years so the employee does not have instant access to convert the awards/options to cash.

Then there are the contingent enhancements floating out there. If our general counsel is fired without cause, he collects $1,300,000. Should he die at his desk or drown in his pool: $500,000. If he is disabled, the payment is $250,000. In addition, at death or disability everything that he has been awarded but has not fully vested, becomes vested. Last, but not least in this age of merger and acquisitions is “Change in Control.” If the company is acquired or changes management through a merger general counsel is due a payment of $1,700,000. For the chief executive of the company that payment is more than $7 million. Obviously, that fellow is enjoying control of a business that pays him annual compensation in the $6-7 million range.

So, what’s reasonable compensation for our general counsel. Suffice to say there is a lot of room between a $500,000 salary and a $2,400,000 package. And in this case, almost two-thirds of that comp is subject to a vesting requirement while riding the tides of the company stock value. In our case, the counsel is holding 70,000 options which are exercisable at prices from $60-80 a share. The company stock ended 2023 trading at $8.00 a share. That’s an ominous sign until you realize that the stock tripled in value between March 2020 (Covid shutdown) and the same time the following year.

In a word; comp is complicated. And just about every person getting comp of any kind will tell you that they are worth more than they are paid. Go to the Bureau of Labor Statistics and it will tell you that in 2023 the mean wage of Pennsylvania lawyers working in executive management was $237,000. But as you can see, that’s often just the start of the reasonable comp journey and not an end.