This is the ninth edition (2024) of our standard reference on executive and director compensation in ESOP companies. The topic raises complex issues, from S corporation anti-abuse rules to ESOP trustee and company board duties. There is no simple solution to executive compensation in ESOP companies, of course. This book, however, provides a guide to the legal, financial, fiduciary, and tax issues involved with various compensation strategies. It also provides best-practice guidelines for how to set executive and director pay. Chapters 1 through 7 cover legal, fiduciary, valuation, and S corporation issues, plus sharing equity and using compensation studies. Chapter 8 analyzes the results of our latest ESOP company executive and board director compensation survey. The data provide a detailed picture of the forms and size of compensation being used in ESOP companies.
The ninth edition includes revisions and updates to every chapter except chapter 5, which did not need any updates. Particularly noteworthy is chapter 8, with its report on our latest survey.
Table of Contents
1. Overview of Executive Compensation for ESOP Companies
2. Legal and Regulatory Issues
3. Fiduciary Issues for Trustees Regarding Corporate Governance and Executive Compensation
4. Sharing Equity with Key Employees and Directors in ESOP Companies
5. Valuation Issues
6. Special Issues for S Corporations
7. Using Compensation Studies Wisely
8. Findings from the 2023 ESOP Compensation Survey
About the Authors
About the NCEO
From chapter 1, "Overview of Executive Compensation for ESOP Companies"
Finally, we at the NCEO recommend, as do leading experts in this field, that incentive awards, including equity, be granted periodically, such as every year, rather than in large one-time awards. Few companies do one-time awards for cash incentives, but many companies make one-time grants of equity to executives. This can be problematic in many ways. First, for options and SARs especially, but other grants as well, an executive who joins in a down year and gets x dollars’ worth of awards is better off than one who joins in an up year and gets the same dollar value, because the first group of executives will get stock at a relatively low price with more upside potential. This adds a kind of lottery effect to compensation. Second, regular grants are more controllable in terms of size, form, and terms because these can be changed year-to-year as needed. Finally, regular awards keep the incentives more in front of people.
Similarly, we recommend mid-term payouts for at least some of the equity awards. Awards that do not pay out for a very long time may be excessively discounted by recipients.
From chapter 3, "Fiduciary Issues for Trustees Regarding Corporate Governance and Executive Compensation"
Boards may want to pay bonuses to the individual shareholders to compensate them for the tax they have to pay on their shares of the income, rather than paying a dividend (which creates a greater outflow of cash), to circumvent the S corporation second-class-of-stock rules when the ESOP does not own all of the shares of a company. However, this would be improper and could endanger the S election. Dividends are paid to all shareholders. The payment of bonuses in this case could be considered as a disguised dividend that does not go to all shareholders. This not only is unfair to the ESOP but also could be treated as creating a second class of common stock that disqualifies the S election.
It is irrelevant whether the trustee is directed or fully discretionary in determining its responsibility to oversee executive compensation. A directed trustee’s fiduciary liability is theoretically lessened due to the trustee being directed by another fiduciary, but the ESOP trustee is charged with the ultimate duty of prudence. Therefore, if it would not be prudent for the directed ESOP trustee to follow directions from another fiduciary that it finds violative of ERISA, the ESOP, or not for the exclusive benefit of the ESOP participants and beneficiaries, the law requires that the directed trustee not follow the directions. For this reason, the ESOP trustee cannot blindly follow directions and must conduct its own analysis to determine that the executive compensation being put in place is fair to the ESOP.
From chapter 8, "Findings from the 2023 ESOP Compensation Survey" (tables omitted)
Table 8-3 shows base pay, cash incentives, and stock-based incentives for each position, broken down by percentiles. Note that percentiles for each pay category are calculated among only those respondents that offer that pay category, and respondents who entered a zero or left their response blank are excluded. For example, cash incentive pay for CEOs is $120,775 at the 50th percentile (median), but this is the median among only those companies that pay cash incentives to their CEO.
Table 8-4 presents total pay amounts. To calculate total compensation, we summed base pay, cash incentive pay, and stock-based compensation for each executive at each company and then calculated percentiles. Deferred compensation is excluded from the total pay calculation. Note that some companies offer all three categories of compensation while others do not; therefore, the total pay at a given percentile is not necessarily equal to the sum of the three corresponding compensation categories in the table.
Table 8-5 presents data on the makeup of total compensation. Base pay accounts for 69% of total compensation for the median CEO, while incentives make up 31% of total pay for the median CEO.