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Develop and install appropriate executive pay arrangement beforehand
Companies fall into one of three major ownership categories: privately owned, publicly traded, and not-for-profit. Each of these categories carries with it specific tax, regulatory and ownership restrictions that impact how they are operated, managed and staffed. For a variety of reasons, most of which include access to a larger market and much greater financial resources, many companies aspire to become public, and as such, venture into the world of the initial public offering (IPO).
The conversion to a public company, with all of its regulations and scrutiny, has inherent responsibilities associated with the requirement for arms-length determination of compensation for senior level executives and board members. Because of the need for transparency and the intention of acting in a more "business-like" manner, many of the same issues occur when a privately owned company is considering its acquisition or merger with another organization.
IPO Compensation Issues
At the time a company is preparing for an IPO, sale or merger, the greatest emphasis is typically on the financial and legal aspects of the transaction, while the people side of the equation is often ignored, or at best, given a secondary consideration. And yet, the original reasons behind the IPO or sale often involve the owner's personal issues such as their desire for an exit strategy and liquidity, as well as related HR issues such as wealth sharing and the retention of key employees.
Some companies proceeded with their IPOs without sufficient preparation for the compensation and people matters. These companies were forced, after the fact, to correct and put in place appropriate executive compensation arrangements, often at considerable cost and anxiety. It is much easier and more effective to develop and install such pay arrangements beforehand, rather than later. To facilitate this process, we have grouped the necessary activities into threemajor time periods: pre-transaction, during the transaction, and post-transaction.
The most important pre-transaction issue is to determine what the goals of the overall executive compensation program will be, and set about to develop a strategy that identifies how to achieve those goals. It is important to add two major caveats here: the first is to establish a longer-term executive compensation strategy that looks at least three to five years into the future, not merely the immediacy needed to prepare for the IPO.
The second caveat is the need to clarify the desired compensation philosophy, which requires documenting such concepts as the specific labor market against which the company will attempt to compete; at what level they will compete (above, middle of the pack, below); to what extent the company will embrace the concept of "pay-for-performance" and the use of variable pay programs; how widely equity and stock based programs will be used, as well as the degree to which various long-term programs will be utilized in the organization; who will receive employment agreements; and a host of similar issues.
It is critical that each of these issues with respect to the compensation philosophy is considered and discussed, since they will serve as the baseline for establishing all specific compensation programs and related documentation. Therefore, the philosophy should:
Following approval of the compensation philosophy by top management and/or the board, the next step is to examine each of the pay components to determine if they are meeting the following considerations:
As part of the evaluation of the current compensation program, it is important to consider the internal procedures used to conduct the competitive due diligence and pay determination, as well as the level and transparency of the requisite process and documentation. This analysis should also consider the administrative controls, policies, and procedures that support all aspects of the compensation program. The Securities and Exchange Commission, as well as each securities exchange, sets forth specific rules that must be followed, the newest of which includes the "say on pay" vote by shareholders. These are continually being tightened, and must be strictly adhered to.
During the Transaction
During the actual preparation in anticipation of the IPO or related action, it may be too late to actually change or put in new plans. This is especially true once the S-1 or "red herring" is prepared and filed, or after the due diligence process has begun. However, before that happens, it may not be too late to consider certain stock grants, finalizing employment and change of control agreements for key management, and correcting other pay deficiencies. These can be especially important if they will enhance the retention of critical personnel and is tied to acceptance of non-compete type restrictions.
The inclusion of the details of the executive compensation components in the prospectus may enhance the total rewards package and signal to the potential shareholders that the compensation is intended to be fair, competitive with peers organizations, and tied to the achievement of meaningful performance goals that follow the concept of pay-for-performance that is directly tied to increases in shareholder value.
As a result of the IPO, sale or merger, the compensation decision-making will be moved from the former owner/managers to the new owners, typically consisting of an independent board of directors or subcommittee of directors. If the transaction was a merger or acquisition, the decision makers may be the senior management or board of the new entity, all of whom are less likely to be familiar with the importance or worth of critical personnel.
The second major change that will occur as a result of the transaction, especially if it is an IPO, is the vastly increased visibility, scrutiny, and required transparency to which executive compensation decisions will now be subjected. Some of the on-going executive compensation needs include the following:
-- Base salary-- Annual incentives.-- Long-term incentives and stock-based plans.-- Equity and stock ownership issues.-- Supplemental benefits and perquisites.-- Deferred compensation arrangements.-- Employment, change of control and severance agreements.-- Board of director compensation.
-- Base salary
-- Annual incentives.
-- Long-term incentives and stock-based plans.
-- Equity and stock ownership issues.
-- Supplemental benefits and perquisites.
-- Deferred compensation arrangements.
-- Employment, change of control and severance agreements.
-- Board of director compensation.
The third post-transaction area requires far more internal examination of competitive market trends and identification of the rationale and justification for all compensation-related actions. This will be required, since all compensation arrangements are now subject to extensive external scrutiny by a variety of sources, including boards, shareholders, the media, and various government agencies.
As noted, the transition from a privately owned company to publicly traded, or merger into another entity, requires a considerable amount of insight and preparation, not the least of which involves a careful review of existing executive compensation programs. The company's key management and its board, as well as with its external legal, financial, and accounting advisors, must ensure that all compensation-related matters are properly handled on a timely basis.
Similarly, it is critical to monitor and renew existing programs as appropriate, to ensure they continue to serve the company's needs, and meet the often changing governmental reporting requirements and regulations.
Paul R. Dorf, ADP, is the managing director of the New Jersey-based consultancy Compensation Resources, Inc. which specializes in providing services for executive and sales compensation, salary administration, performance management and litigation support. © 2013 Compensation Resources, Inc. All rights reserved. Republished with permission.
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