Well-structured executive compensation packages can attract talented leaders to C-suite and top-tier management positions. Companies must consider the impact those offers might have on their employees and businesses.
Providing a clear rationale for high-level salaries and benefits supports employee productivity and morale throughout an organization. Getting it wrong can have a detrimental impact on company culture and can also lead to fines, sanctions, tax penalties, lawsuits or reputational damage.
LizAnn Eisen, faculty director for the Cornell Tech Board of Directors Forum and acting professor of the practice at Cornell Law School and Cornell Tech, recently hosted a Cornell Keynote discussion of executive pay featuring Jessica McNamara ‘96, senior counsel at IBM, and Jennifer Conway, a partner at Davis Polk. The trio covered strategies for ensuring an organization’s pay structures align with regulatory requirements and best practices for perks, clawback and noncompetes.
1. Prioritize transparency and cross-team alignment on perks.
The crescendoing call for transparency in executive pay calculations includes non-cash benefits, or perks, such as travel on company aircraft, personal security and country club memberships. Corporate leadership teams can sometimes find it difficult to distinguish business expenses from disclosable perks.
“The SEC (U.S. Securities and Exchange Commission) considers a personal benefit to be a perk unless it’s integrally and directly related to the performance of duties,” Conway said. “If it’s a perk, then it has to be valued based on the aggregate incremental cost to the company — the cost of providing the perk — which sounds simple, but it can actually be very complicated.”
While SEC rules apply only to public companies, the Internal Revenue Service (IRS) monitors all businesses for non-cash, in-kind fringe benefits provided to any worker in exchange for services, focusing on whether employers are properly reporting employee income. A taxable fringe benefit requires imputing income based on fair market value.
Both SEC enforcement action for inadequate perk disclosure, which the commission sees as a possible breakdown of internal controls, and audit activity from the IRS regarding personal trips reported as business travel have increased recently.
When dealing with the two different sets of federal standards for perks, McNamara advises that companies make sure their practice is robust using three key steps:
- Have clear written policies and approval processes applicable to benefits like the use of corporate aircraft.
- Maintain a detailed record-keeping system and automate inputs when possible.
- Do monthly and year-end reviews with all key stakeholders, including administrative assistants and human resources, legal and tax departments.
2. Understand the latest rules on compensation recovery.
Last fall, the SEC adopted the final clawback rule mandated by the Dodd-Frank Act. The act subjects erroneously paid compensation to recovery and applies to top officers of a company. The no-fault component of the rule is new: Even if an executive had no role in their organization’s misstatement of finances, their excess compensation tied to meeting performance or revenue goals now could be subject to recovery.
In restatement processes, some areas for repayment like performance-based bonuses should be apparent, but retirement plan contributions and payments based on stock-price changes could slip through the cracks. The risk for litigation, according to Conway, makes it important for businesses to be thorough.
“Given the complexity, it’s important to work with outside counsel,” she said. “It’s also helpful to make sure that you’re correctly calculating what’s subject to recovery.”
To ensure that its executives are aware of the new clawback rules, IBM’s legal team added language regarding recovery and repayment provisions to its equity award agreements, McNamara said.
3. Prepare for a future that may not include noncompetes.
The Federal Trade Commission’s recent ruling to end noncompetes is set to take effect in September, but there have been legal challenges to the agency’s authority. From the major questions doctrine to the rule’s retroactivity, every matter of the potential ban is up for debate.
“There’s a good chance that the rule never goes into effect, but it’s definitely important to take very close note of it. On the state level, there is much more momentum to act,” Conway said.
If the ban were to be enforced, it would prohibit any term or condition of employment that intends to prevent a worker from seeking other work once they have left a company. While the rule would be retroactive, an exception applies to a limited group of senior executives who serve in policymaking positions and whose compensation exceeds $150,000 annually.
According to Conway, one of the most significant portions of the new rule impacts noncompetes tied to the sale of a business.
“The final rule does not apply to noncompetes entered into by a person pursuant to a bona fide sale of a business entity, sale of the person’s ownership interest in a business entity or all or substantially all of the business’s operating assets,” Conway said. “That raises a question of how small an ownership might be sufficient. Is it so broad that you could cover somebody with just a small interest in equity of a public company? As the rule is currently drafted, it doesn’t actually impose any sort of threshold.”
For IBM, which has acquired several companies — including many in California where a sale-of-business exception to prohibitions on noncompetes has existed for some time — not having a threshold is important for protecting the good will of businesses that they purchase McNamara said.
Given the litigation challenges, companies do not have to alter their existing practices right now, Conway said, but they can engage in certain activities to prepare for the future:
- Review restrictive covenants, assess how broadly they apply and consider which ones are necessary.
- Evaluate “blue pencil” provisions.
- Include acknowledgements of senior executive status in new noncompetes.
- Strengthen non-solicit, confidentiality and intellectual property (IP) covenants.
- Review overall compensation plan structures to ensure they are designed to give employees incentives to stay.
“Once the IP walks out the door and someone starts work the next day for somebody, the only real method [for relief] is an injunction. If the injunction isn’t granted, there’s no equitable relief that can get the IP back. The damage is done,” McNamara said. “The noncompete is a nice way for people to sit out for a period so their information becomes stale. A reasonable rule, even if it applies to a level of technical talent you need to protect . . . would be much more palatable to the business community.”
Visit the eCornell website to watch the full Keynote “Executive Pay in the Spotlight: Perks, Noncompetes and More,” one webcast in a multipart series leading up to the Cornell Tech Board of Directors Forum. The immersive forum will prepare you for today’s most urgent opportunities and challenges in board governance, including AI and other developing technologies. Learn more and register.
