Linda Wilkins
Wilkins Finston Friedman Law Group, LLP

Our March 2010 meeting of the Pearson Partners DFW HR Roundtable featured a lively and informative discussion of trends in executive compensation and benefits. Our guest speaker was Linda Wilkins, a board certified tax attorney with over 25 years of experience in executive compensation strategies, benefit plans, employment contracts and long-term incentive plans. We later sat down with Linda for an in-depth discussion of some of the trends she and her peers are seeing in executive compensation and benefits.

What trends are you seeing in executive compensation and benefit packages? What do you foresee as we climb out of the recession and funds are loosened up?

It has become apparent, especially in the financial services industry, that short-term incentives can definitely increase risk to a company’s financial survival so companies are looking more towards long-term incentives. There’s a move toward tying executives to owning stock for an extended holding period; often until retirement. Thus the executives have “skin in the game” and can then focus on longer term performance for the company. Furthermore, companies are implementing “clawback” policies which require an executive to repay short-term bonuses that were earned based on financial performance if at a later time financial statements are found to have been erroneous or need to be restated.

For example, we had a whole spate of backdating of stock options which resulted in a lot of public companies having to restate their financials; with a lot of additional financial accounting charges. So we are seeing clawbacks now incorporated into compensation programs.

Many of my clients have eliminated their 401(k) matching contributions. I see companies starting to think about a timeline for re-implementing a match. Most have not reached that point yet, but I think in the recovery we will get there.

Increasing costs of group medical plans have led more employers to look at cost containment strategies like wellness programs, encouraging employees to have better management of their chronic health conditions. Companies are starting to put in some corresponding penalties, so if employees don’t comply with the recommended medical management, they face higher deductibles and higher premiums.

How do you boost morale and retain employees when business performance is such that bonuses aren’t being paid and stock is at a low point?

You might award stock options. If your share price is really depressed, there’s a lot of potential upside there that can be a good retention tool. I think stock appreciation rights are better than stock options because they don’t dilute your equity pool in your plan as much.

What are companies doing today in their severance packages?

Public companies are under pressure to justify every element of post-termination pay because of new SEC disclosure rules. There is a trend toward employment agreements with sunset provisions. Rich severance packages are no longer going to be offered on an evergreen basis.
For a recruited executive, he or she may have limited severance protection for, say, two years but after that the contract would be renegotiated and there would be no guarantee of ongoing severance. By that point, the individual should have begun to accumulate some value through long- term incentives and wouldn’t really need the protection of the severance pay.

How are board members being compensated for the big increase in work and risk today in the face of declining compensation budgets?

Often a significant amount of directors’ pay is in the form of restricted stock awards with a very short vesting schedule. Audit and Compensation committee chairs take on considerable additional work and risk, so we are seeing significant cash retainers for them.

What trends do you see with private companies?

There’s a significant difference in equity opportunities in private companies. A lot of private companies will compensate based on appreciation in business value, which is like synthetic equity. Frequently these arrangements are tied to an exit strategy for the company where the payments are triggered on a liquidity event.

Often, the top executives are given significant equity and are asked to invest their own funds in an acquisition, so private equity firms are really a different animal when it comes to equity participation. Often a percentage, say 4-10%, of the business is allocated to key management executives. This gives them a huge performance incentive and golden handcuffs as well.

I think many private companies do not recognize the need for good corporate governance and formalized documentation of their executive compensation programs. For example, private companies frequently recruit key people through offer letters, which are often the only written document to describe the individual’s compensation and equity sharing arrangement. When stock options are not properly documented and formally granted, there is significant risk of tax liabilities and unrecognized compensation expense. There should be a stronger focus on governance and thorough documentation just like there has been in public companies.

How do human resources executives stay current on all of these issues, in the face of so many economic, political and legislation changes, and protect themselves and their organization?

Staying current is a huge challenge. The HR function oversees so many areas that are not only highly technical and costly, but fraught with potential liability. HR executives should have outside advisors, participate in trade associations and staff adequately with individuals who have expertise in recruiting, compensation and employee benefits. In today’s world you have to take advantage of all kinds of opportunities for learning experiences. Attending educational events such as this DFW HR Roundtable and other trade association meetings is a great way to stay on top of all of that. You can focus on current trends and be alert to areas where you’re going to incur risks and liabilities for your organization.

How would you advise individual executives on negotiating employment and severance agreements?

If it’s a public company, they should look at (or ask to see) current executive contracts, which are publicly available, to see what is in the realm of possibility. They should tally what they’re walking away from with their current employer. The new employer needs to compensate for the loss of that package.

Many companies do not have employment agreements, but have severance or change-of-control agreements. Executives should review the terms regarding termination “for cause” and “not for cause.” There should be a clear definition of cause so the executive can’t be terminated based on some subjective performance issue. There should be no section 409A rules violations with regard to the design of severance pay. If an employment is for a fixed term with renewal clauses, it should specify whether the company’s non-renewal of the contract allows the executive to terminate for good reason and be paid severance.

First and foremost, executives should get good legal advice. It’s important to work with counsel that knows what’s typical in these agreements.