CEO Compensation: The ABCs of Paying Yourself
Advice from experts and CEOs that adds up to primer for execs to figure out their annual salaries.
What matters most, which mistakes to avoid, and where to turn for advice
H ow Do You Decide What's Important?
In a survey of past Inc . 500 companies we asked chief executives some specific questions about the considerations that went into their compensation decisions. (See chart, below.) CEOs also told us what their greatest concerns were as they contemplated how much money to take out of their companies this year. A founder of a high-tech start-up, for example, tosses and turns over "how much to allocate to research and development in relation to market saturation." Similarly, the captain of a cash-starved business is obsessed with "meeting debt-to-equity ratios and other financial tests used by lenders to extend credit." Some CEOs have precise formulas for calibrating salary increases ("one-half the increase in sales, plus 5% of pretax profits"); others are more scattershot ("what the company can afford and remain competitive").
Yet the primary concerns that creep into the decision-making process are universal. They have everything to do with "company needs," which boil down to cash flow and profitability -- present and future. "We focus on the profit-and-loss performance to improve the company's value," says one CEO, "and we need adequate cash to expand the executive management team to take us to the next tier." And still another says he leaves "a substantial cushion in case of a downturn."
So maybe we shouldn't be surprised that only 17% of those who responded to our survey indicated that lifestyle choices are very important to their pay decisions. What's good for the company is apparently good for the CEO. "As the company grows, my personal wealth grows faster than it would if I took money, paid taxes, and invested it elsewhere," explains one CEO. "Company stability is more important to me now than personal convenience or luxury. I can't talk to my people about keeping costs down to compete if I drive a BMW."
Take a look at the responses, below:
* * * What Influences CEOs' Compensation Decisions
To arrive at my total compensation, I am influenced by --
Very Not
important Important important
Company's needs 80% 15% 1%
Increasing my net worth 33% 33% 20%
Lifestyle choices 17% 47% 29%
Employees' perceptions 13% 48% 30%
Industry norms 11% 34% 47%
If You Want Advice, Where Do You Go?
Half the CEOs we surveyed look only to themselves for guidance about how much to take out of and how much to leave in their companies. As for the sources tapped by the other half, boards, accountants, and published surveys rank highest, closely followed by trade-association data. As advice givers, spouses just beat out compensation experts.
CEOs we talked with also supplement national salary surveys conducted by accounting firms, trade associations, and compensation specialists with regional, state, and even city surveys conducted by departments of employment, private-industry groups, chambers of commerce, and associations of human-resources professionals. Following are some of the paths CEOs have taken to come up with their own compensation figures.
Targeted associations. If you're in a fast-growing, fragmented industry, finding accurate salary data that reflect the economic reality of your niche can be daunting. Such was the case for Julie Prafke, the president of Humanix Corp., a $10-million temporary-placement agency in Spokane, Wash. Because her primary trade association (the National Association of Personnel Consultants) includes many permanent-placement agencies, whose CEOs lie on a higher pay plane, Prafke had difficulty pinpointing where, exactly, she fit in. Networking led her to a professional association of independent temp agencies, which compiles compensation surveys. By participating in those surveys -- which takes her maybe an afternoon a year -- Prafke receives privileged, useful information for the price of her membership.
But to price yourself accurately, warns Harry Geller, you have to use survey results correctly. For instance, Geller, the CEO of $25-million Global Mail, in Sterling, Va., analyzes the annual compensation report published by his trade association, the Air Courier Conference of America. According to its executive summary, CEOs take out an average of about $600,000 -- an average, notes Geller, that could include the paychecks of Fred Smith of Federal Express and Kent Nelson of United Parcel Service. "Look more carefully at the medians and modes for the annual revenue range you fall into," Geller advises.
Executive-search firms. Don't cringe. Good headhunters publish their own salary surveys for internal use, know the cost of CEO talent in their market, and can provide you with hard-to-find surveys. "We're in retail, and 90% of key executives in specialty retail use one main recruiting firm in the area," says Orv Madden, CEO of Hot Topic, a $25-million specialty retailer of music-licensed fashions in Pomona, Calif. That made shopping for a search firm easier, Madden admits, but getting it to work with him on an ongoing basis meant forging relationships with two of the firm's principals. When he's recruiting, Madden rings up those inside contacts for other salary information as well. He also likes fresh retail-industry surveys, such as one published by the National Retail Federation, in Washington, D.C.
Chief executive Julie Wang went a step further and made her headhunter, who specializes in fast-growing public-relations companies, an informal adviser to her business, $5-million Wang Health Communications, in New York City. Wang's expertise has helped the headhunter develop his health-care niche, and in return he has found her five senior people, including the person who is now Wang's business partner -- who, it turns out, was making double Wang's salary. That forced Wang to focus on her own pay and on how to value her specific contributions as a leader and not just a founder. "In the end we negotiated a middle ground," she says.
CEO roundtables. From informal breakfasts to exclusive forums, peer exchanges are invaluable -- especially when groups are small and discussions are confidential and frequent. Marion McGovern, the president of M2 Inc., a consultant brokerage firm in San Francisco, prefers Young Entrepreneurs Organization forums, attended by company founders who have grossed $1 million in revenues by age 35. "We're all at the same point in our lives, and we have the same pressures," McGovern says. "You bare your soul -- covering everything from building your own incentives to getting employees to buy into them. You hear about what works, what doesn't, and why."
