Toolkit: Design Competitive Executive Compensation Plans With Confidence
Access SHRM's comprehensive toolkit to gain insights, strategies, and tools for aligning executive pay with organizational goals, market trends, and compliance requirements.
Incentivizing executives to meet business objectives is a critical factor in designing executive compensation plans. Organizations can choose from several well-established methods to pay for the performance of executives, often with significant tax advantages to the executive and the employer.
It has become increasingly more important to ensure that the public and elected officials can readily grasp the reasonableness of executive compensation plans, especially at public corporations. The plans have come under significant regulatory and political attack and garnered high-voltage attention in the media in tandem with a “meteoric rise” in CEO compensation. The public often does not understand that executive compensation is a matter of meeting — and beating — global competition to attract the best and brightest executive talent.
At the same time, executive compensation plans have led to the abuse of both public funds and the interests of private shareholders, as noted in a notable case involving Tesla CEO Elon Musk. Given this legal, social, and political environment, a straightforward and well-balanced assessment of key design components in these plans is vital for HR professionals.
A sound executive compensation program depends on good governance and well-established compensation philosophies, policies, and practices that are closely aligned with the organization’s overall goals and objectives. HR should consult with legal counsel to ensure compliance with the latest iteration of the laws related to executive compensation.
Leading the Way: Empowering Women in Executive Roles
Learn how HR can support inclusion and diversity hiring efforts at the executive level in this Alll Things Work podcast episode with Jennifer Broerman Spencer, Lenovo’s director of global diversity and inclusion. She shares the journey and strategies behind promoting more women into leadership roles at Lenovo.
HR’s Role
The most basic role an HR professional plays is informing management of the benefits, costs, and array of options in launching or improving an executive compensation program. This includes assessing the adequacy of the technology and methods needed to develop incentives.
HR professionals are key in determining what in-house and outside expertise is necessary for the program to be successful. Almost every organization needs some degree of outside expertise for the design and management of an effective executive compensation program.
Communication
Communication is one of the most important roles for HR in plan development, and it is a key component for success in developing effective messaging to internal and external stakeholders. Communications are multilayered and take place with other compensation professionals, executives, the board of directors, and possibly the media and governmental agencies, in addition to employees, all of whom require a strategic approach.
A strategic communications plan is essential, as the failure of many executive compensation programs can be linked to failures in the communication process, such as:
- Failure to obtain employee input in programs that will actually incentivize executive performance.
- Failure to clearly define performance goals upfront.
- Failure to create performance goals that are within the scope of influence.
- Changing performance standards midstream without communicating.
- Judging performance according to standards that were not stated in the plan.
- Providing job descriptions that do not reflect goals set forth in the plan.
A compensation philosophy that helps explain the “why” behind executive pay can serve as a starting point.
Pro Tip
Having a clearly communicated compensation philosophy that addresses the company’s executive compensation strategy can help prevent employee perceptions of unfair executive pay.
Plan Design
Designing an effective executive compensation plan requires organizations to balance shareholder alignment; performance-based pay; recruitment and retention; and the assessment of cost versus perceived value. A long-term compensation plan with performance-based incentive vehicles can help achieve that balance.
Executives are privy to a wide range of compensation arrangements that may include several employees, or they may consist of individual agreements between the organization and one executive. The HR Policy Association’s Center on Executive Compensation notes six distinct compensation components that are explored later in this toolkit:
- Salary.
- Annual/Short-Term Incentives.
- Long-Term Incentives.
- Benefits.
- Perquisites.
- Severance/Change-in-Control Agreements.
Market trends related to executive compensation include the following:
- A growing wave of C-suite leadership turnover indicates that a large majority of C-suite executives (CxOs) are being tasked with doing more.
- Overall compensation trends in 2025 indicate a continued focus on increased pay transparency and slowing pay increases.
- Employers are facing an ongoing labor shortage and economic uncertainty.
- Nonfinancial environmental, social, and governance (ESG) metrics are generating more debate.
- Pay in the C-suite has risen faster for roles other than the CEO in tandem with the de-stigmatization of executive job hopping, making it a less attractive position, though CEO pay has continued to increase in tandem with strong shareholder returns.
- Pay incentives are more focused on long-term results, with long-term incentives such as stock options often making up more than 60% of total direct compensation.
- Politicians and the media have made the case that prevailing executive compensation practices drive employees to take short-term risks with little consideration for long-term effects on the organization and the overall economy.
- Regulatory proposals have suggested that employers offer more pay through restricted stock or other forms of long-term incentives that are designed to not reward short-term performance.
- Companies have cut back on perquisites for executives, especially the types most likely to raise shareholder ire — such as cushy severance packages, tax gross-up calcuations on golden parachutes, spousal travel, cars, and private security.
- AI is an emerging trend in designing executive compensation programs.
Senior leaders with greater autonomy and flexibility over their working arrangements and benefits experience greater job satisfaction. In this All Things Work podcast episode, Rob Hosking, executive director of administrative and customer support at Robert Half, shares how to emphasize individual job satisfaction while balancing organizational needs.
SHRM Resource
Pro Tip
Expanding the executive compensation package beyond a base salary and an annual cash incentive plan involves a number of complex accounting, tax, regulatory, cost, and documentation issues. When considering the range of alternatives, employers should seek the advice and counsel of knowledgeable legal, technical, and consulting professionals.
Total Compensation Strategy
Each element of an executive compensation plan contains various degrees of accounting, tax, and regulatory considerations. Organizations need to develop a strategy for how they will use each of these elements.
The total compensation strategy should be up-to-date and also address benefits such as health coverage, retirement, life and disability insurance, and capital accumulation plans, as a comprehensive benefits package remains essential for executives. These types of benefits, unlike vacation, holiday, and paid-time-off plans, are directly affected by changes in business conditions.
Compensation rates and trends among comparable organizations are important factors in determining executive direct and indirect pay. Compensation data surveys have more relevance for private companies, but employers should note that these surveys:
- Represent the market value of the role, not the value of the person in the role at your company.
- Represent how the role is valued at companies other than yours.
- Don’t consider different levels of experience in the role.
- Don’t reflect the surveyed companies’ pay positioning and pay-mix philosophies.
- Don’t capture the unique mix of cash and long-term deferred cash/phantom ownership opportunities that commonly exist in privately held companies.
Direct Compensation
Most companies target executive compensation in the midpoint at or near the 50th percentile, according to a survey by Pearl Meyer, an executive leadership consulting firm. While a traditional salary range is commonly 30%-40%, top salary grades for executives commonly have a wider range sometimes greater than 40%.
Base Salary: Employers typically identify target amounts for each element of the executive compensation plan and express them as a percentage of base salary. Base pay rates are heavily influenced by compensation trends in the local or regional labor market. For executive-level jobs, the direct pay criteria are predominantly the type of industry and the size of the organization as measured by sales revenue or assets.
Annual Incentives and Bonuses: Incentive compensation has grown in importance as organizations have continued to refine their methods of paying for performance. Executive compensation is increasingly tied to pay-for-performance methodology, with performance-based cash bonuses used to motivate executives to reach organizational and individual goals.
Bonuses may be paid as a fixed amount or as a percentage of sales or profits. Bonus percentages can vary widely depending on several factors, such as:
- The industry.
- An organization’s view of the at-risk element of direct pay.
- The level of the job within the organizational structure.
- Numerous combinations of overall organizational priorities and objectives.
- A specific unit or department.
- An individual’s job performance or contributions to an organization’s revenue.
Environmental, Social, and Governance (ESG). These metrics are commonly added to executive incentive compensation plans but as noted earlier, they are generating more debate. Using a structured framework for discussions can accomplish the following:
- Identify key values that all can agree on.
- For publicly held companies, gauge shareholder sentiment.
- Consider what your candidates and employees want from your company.
- Identify your desired company culture.
- Balance the financial picture.
- Set priorities.
Employers should also consider the message that their incentive plans send about what they don’t incentivize.
Long-Term Incentives and Stock Options: Long-term incentive plans (LTIPs) typically have performance measurement periods of three years or more and usually include stock options for publicly traded companies. Companies that plan to go public should carefully review their options for compensation plans.
Nonqualified stock option. The most common long-term incentive arrangement, this option allows an executive to purchase stock from the company at a specific price — usually the fair market value — over an extended period of time. If the stock price falls below the price paid, or if the stock option will not return a profit for reasons beyond the control of the executive (for example, a natural disaster, terrorism, or a scandal involving a different executive), then the incentive value is lost.
Incentive stock options and restricted stock grants. These plans each have different eligibility requirements, grant sizes, or company and personal tax implications. The plans may be used alone or in combination with nonqualified stock options.
Phantom stock. Organizations that do not have publicly traded stock may provide executives with longer-term compensation plans by using other types of organizational performance measures such as cash or phantom stocks. The value of a hypothetical stock unit is linked to the book value of the organization at various points in time, or it appreciates in value with a precise formula.
Alternative long-term incentives can be key for private family-run businesses looking to recruit outside talent.
Pro Tip
Equity-based incentives are generally less common at private companies, which may not have enough liquidity, may rely more heavily on cash, and do not have the same disclosure requirements as publicly traded companies.
Benefits
A comprehensive benefits package — including private medical insurance (the top priority), retirement plans, bonuses, and flexible work options remains essential for executives, according to a 2025 report by Page Executive, a global executive search firm.
Supplemental Health Benefits
Supplemental health and welfare benefits may be automatic and fully paid (or reimbursed) or provided by the employer. Some organizations make a range of choices available to the executive, either within an existing pretax payment plan provided to all employees or as a voluntary out-of-pocket, after-tax expense to be paid by the executive. These types of executive benefits include:
- Supplemental life insurance.
- Split-dollar life insurance.
- Supplemental disability insurance.
- Long-term-care insurance.
- Job-related liability insurance.
- Supplemental medical insurance or reimbursement.
- Extra or special vacation day allowances or sabbatical leaves of absence.
Perquisites and Fringe Benefits
Indirect pay or noncash privileges called perquisites or perks are generally noncash fringe benefits that provide an immediate financial reward. Examples include:
- Employer-provided vehicles.
- Paid meals and lodging.
- Use of eating and athletic facilities.
- Paid entertainment expenses.
- Educational reimbursement plans.
- Free parking.
- Vacations.
- Country club memberships.
- Cellphones and laptops.
The value of all fringe benefits must be included in an employee’s wages for income tax and employment tax purposes, unless they are specifically excluded or exempt from taxation as defined by the IRS.
Nonqualified Retirement Plans
Nonqualified plans, unlike a 401(k), do not meet the criteria for pretax treatment under the Internal Revenue Code, making them disadvantageous to employees and employers from a tax perspective. They are also not subject to the Employee Retirement Income Security Act (ERISA) because they are often designed to provide additional benefits only to highly paid employees. Unlike qualified plans, being exempted from many ERISA requirements means related reporting rules, contribution limits, and distribution mandates do not apply. An advantage to both employers and executives is that the absence of ERISA requirements offers more flexibility in compensation arrangements for executives. The disadvantage to employees is the lack of protection that ERISA otherwise provides to qualified retirement plans, such as in the event of employer bankruptcy.
Deferred Compensation
Due to the limitations imposed on qualified plans, executives are often not able to fully participate in an employer’s tax-deferred savings plans. Nonqualified deferred compensation (NQDC) plans, one of the most popular options, allow executives to defer part or all of their compensation until sometime in the future, which can significantly reduce their tax liability. For an NQDC plan to retain a tax-deferred status, it must meet the following criteria:
- The employee is not in constructive receipt of the amount promised, which means the employee has no right to receive or turn down the benefit.
- The employee does not receive an economic benefit from the compensation. For example, the employee cannot use the promised benefit as security for a loan.
- A substantial risk of forfeiture must exist. That is, the executive’s ownership is contingent on meeting certain conditions and goals, and ownership is forfeited if those goals or conditions are not met.
The plan usually credits interest to the deferrals, which allows executives to maximize tax-deferred growth and take their total earnings over an extended period of time. Executives can choose to defer a significant amount of their salary or bonus and write their own pre- and post-retirement options. As executives’ needs change, so can the amount of deferrals and future payout arrangements.
Supplemental Executive Retirement Plans
One example of a nonqualified benefits plan is a supplemental executive retirement plan (SERP). A SERP may be offered to meet a number of different goals, including making up benefits lost in other retirement plans. Unlike a deferred compensation plan, a SERP is generally paid solely by the employer to offset the disparity in retirement benefits between key executives and other employees. A SERP provides retirement benefits that may not be provided through the employer’s regular retirement plan because the level of benefits would cause the plan to violate nondiscrimination rules or would exceed specified caps on maximum benefits or compensation that can be provided.
A SERP can consider all executive income, including bonuses and other incentives that exceed the compensation dollar limit for qualified retirement plans. For organizations with defined benefit pension plans, this can be an attractive executive retention tool.
Golden Handcuffs
A golden handcuff is a benefit, payment, or incentive designed to retain employees by making it financially or professionally disadvantageous for them to leave the company before a specified period. Examples include requiring employees to repay hiring bonuses, education expenses, or relocation costs if they leave within one to three years, as well as deferred compensation, stock options with vesting schedules, or retention bonuses tied to tenure.
Employers can instead use various kinds of NQDC plans. Typically set up as 401(k) mirror accounts, they allow executives flexibility to invest money for retirement without immediate tax consequences. Another similar tactic is to provide a SERP that acts like a pension — as long as the employee makes it to retirement with the organization. The major disadvantage of retirement-based handcuffs is that they may be far less effective with younger executives.
Employers may also offer split-dollar insurance plans. Some executives have large estates that will be subject to hefty estate taxes when they die. To address this concern, some organizations pay for life insurance policies, the proceeds of which will be paid to family trusts, free of estate taxes, after the executive dies. An executive who leaves the company before death or retirement loses that insurance. When considering split-dollar insurance, it is imperative to review the details carefully, keeping in mind that premiums may not be deductible by either the employee or the employer.
Pro Tip
Although the use of perks has been a longstanding practice, many organizations have started cutting back on perks and fringe benefits they provide to executives as a result of increased scrutiny and government regulations.
Pro Tip
To ensure exemption from ERISA mandates, employers should not offer nonqualifed deferred compensation plans to more than the top 10% of earners.
Need more guidance on designing your executive compensation plan?
Pro Tip
In some organizations, deferred compensation plans are instituted simply to provide supplemental retirement income for a select group of highly paid personnel as an incentive to encourage prospective midcareer executives to join an organization.
Focus on Attracting and Retaining Top Talent
In today’s job market, the number of available positions significantly exceeds the pool of qualified talent. Workers are seeking more than just competitive salaries, and every compensation plan has its limits. SHRM’s Total Rewards Specialty Credential offers the knowledge and guidance needed to create a comprehensive Total Rewards strategy, enabling your organization to attract and retain top talent.
Compensation Agreements
The various elements of direct and indirect compensation included in the pay package of an executive are often expressly outlined in a formal employment agreement that spans multiple years.
These agreements may also include special severance pay arrangements that become effective when an involuntary termination occurs or when there is a change of control due to a merger or acquisition.
Some employers also establish formal plans for deferring current compensation to a point in time when an executive’s marginal tax rate may be lower. It is not uncommon for executive pay packages to include one or more nonqualified deferred compensation plans specifically designed to provide retirement income that makes up for benefits payments that would have been available from any qualified plan or plans provided to all employees.
Change in Control and Severance Agreements
Rabbi Trusts: Protecting plan assets ensures executives receive promised benefits during mergers or acquisitions. The rabbi trust, a popular employer-established vehicle, secures funds for nonqualified plans, offering executives assurance of payment. However, trust assets remain at risk, as they are subject to creditor claims in case of employer bankruptcy or insolvency.
Golden Parachutes: Golden parachutes are executive compensation agreements that provide parachute payments, often exceeding the executive’s usual compensation, during a change in company ownership or control. Parachute payments may include cash, stock options, pensions, insurance payouts, or noncompete agreements.
Ownership changes occur when one person or group acquires:
- At least 50% of the corporation’s fair market value or voting power.
- Assets worth at least one-third of the corporation’s total gross fair market value within 12 months.
Effective control changes are presumed when:
- At least 20% of voting power is acquired within 12 months.
- A majority of the board is replaced within 12 months by directors not endorsed by the current board.
Golden parachutes are primarily governed by Section 280G and Section 4999 of the Internal Revenue Code (IRC).
Parachute payments: When a parachute payment equals or exceeds three times an individual’s base compensation (average taxable compensation over the past five years), it is considered an excess parachute payment, which is not deductible by the employer under Section 280G and is subject to a 20% nondeductible excise tax under Section 4999.
Pro Tip
Golden parachutes are often used by employers as a defensive measure to prevent hostile takeovers under the assumption that the guarantee of additional financial benefits to executives will increase the cost of the acquisition and discourage prospective purchasers.
Legal and Compliance Issues at Publicly Traded Companies
Compliance with the many legislative and regulatory requirements surrounding executive compensation and nonqualified deferred compensation plans is critical to avoid sanctions, fines, and potential disqualification of the plans themselves.
Over the past several years, Congress and other governmental agencies have made significant changes to the rules governing executive compensation and NQDC plans.
Employers that maintain NQDC plans for executives must be aware of these rules, which require that many of these plans be amended periodically. Additionally, employers must address new tax reporting rules, disclosure statements, and proxy statements as they occur.
Pro Tip
New rules from the Securities and Exchange Commission (SEC) in 2023 impacting executive pay require companies to clearly disclose the relationship between executive compensation and financial performance.