For many executives, cash is king when negotiating a compensation package. But amid challenging economic times such as the current pandemic, companies may hesitate to commit to large base salaries when cashflow is tight and the business climate remains uncertain.
In such unpredictable circumstances, companies prefer to tie executive compensation to future success. This means executives should pivot their negotiating tactics — and mindsets — toward alternative forms of compensation that focus less on cold, hard cash and more on overall value and total worth. For executives confident in the company’s vision and their own ability to help it grow, this approach can lead toward a package that adequately compensates for their talent and expertise while providing the business with cashflow and operational flexibility during turbulent times.
Here is a breakdown of common compensation alternatives to explore in negotiations:
Deferred Compensation Plans
Deferred compensation plans may be worth considering, especially by executives in a high tax bracket. As the name implies, these plans allow an executive to defer receiving — and paying taxes on — a portion of income until a future date. For example, a salary or bonus deferral plan might enable an executive to receive an annual bonus in January rather than December. This would allow the business an extra month of cashflow flexibility while also providing the executive the benefit of deferring taxes on the bonus by a full year.
Another deferred compensation option is a Supplemental Executive Retirement Plan, in which an employer will set aside funds in a separate account that can’t be touched for a period of time. Eligibility to receive the benefit of these discretionary contributions typically requires an executive to stay with the company for a certain period of time, but distributions from the plan can supplement the executive’s future retirement income.
Equity-based compensation is the most common alternative for an executive looking to maximize compensation with an employer that is unwilling or unable to commit to a high base salary. But not all equity options are created equal. Executives must take care to understand the differences among the various equity awards when negotiating for them.
- Stock options: Broadly speaking, an “option” provides an executive the right to buy shares of company stock at a predetermined price in the future. The benefit is that at the time of exercise, the difference in the price paid for shares and current market value of those shares may be significant. However, contrary to popular belief, not all stock options are created equal. Consider, for example, the difference between qualified Incentive Stock Options (ISOs) and Non-Qualified (also called Non-Statutory) Stock Options or NSOs. Although no tax is due on the issue date of either option type, the tax due upon the exercise and future sale of each differs substantially. With ISOs, no tax is due upon exercise, but the future sale of ISO shares may qualify for long-term capital gain tax treatment. In contrast, NSOs are subject to ordinary income tax on the spread (the difference between the exercise price and fair market value) upon their exercise. This difference can be very important in determining an exercise strategy.
- Restricted stock: This is a stock award granted to an executive that cannot be sold or transferred until a scheduled date in the future. Unlike stock options, executives don’t have to pay out of pocket for shares of restricted stock. Shares are subject to income tax the year they become vested.
- Phantom stock: Phantom stock is a compensation award in which a company agrees to pay the recipient a cash payment in the amount equal to the market value of company stock at a future date. This type of award provides executives with “skin in the game” without actually owning shares of stock. The value of the payout increases along with the value of the company’s stock.
- Stock Appreciation Rights: SARs are a form of compensation tied to the value of a company’s stock price during a fixed period of time. Unlike stock options, SARs are usually paid out in cash and do not require an executive to own or purchase shares.
Executives shouldn’t forget about more traditional benefits and compensation such as health, dental, life and disability insurance plans, as well as pension or 401(k) offerings that can and should be negotiated. A business looking to save on cash may be amenable to providing additional PTO or vacation days.
Focus on Personal Value
Regardless of the type of compensation executives pursue in negotiations, it is incumbent upon them to make the case to their prospective employer. They must help the company understand why the compensation request makes sense and is deserved.
In other words, executives should focus on articulating the value they bring to their prospective employer rather than dwell on how the potential package compares to their current or previous compensation.
Even in a challenging business climate, emphasizing value in negotiating executive compensation ensures the interests of both employer and executive are in alignment, with risk and reward shared equally between both parties.
Kris Yamano is a market leader with BMO Wealth Management. She leads a team of professionals dedicated to providing high-net-worth families, closely held businesses and charitable organizations with a full range of customized wealth services that include investment management, private banking, trust and estate services, and comprehensive wealth planning.