The Expert CEO

Economic conditions are grim, with no end in sight; recriminations surrounding overpaid executives continue to make headlines, especially throughout the financial industry. At the top of the list is the 3.6 billion in bonuses paid to Merrill Lynch executives after the firm lost 15.8 billion in Q4 2008 (see WSJ article).

The vast majority of the members of ExpertCEO are in a different category – mostly small to mid-sized businesses, roughly 2/3 of whom are in the technology industry. Nevertheless, the issues involving CEO compensation in small and mid-size companies are just as real and potentially just as complex.

ExpertCEO recently conducted a compensation survey among its members, and not surprisingly, we had a record response – this is a topic near and dear to most everyone. One of the interesting results from the survey was that, while only 35% of our members received bonuses in 2008, 56% expect to receive one in 2009. The average salary for 2009 was projected to be level with the average for 2008, at just over $200,000. It will be interesting to see the results of a follow-up survey later this year to see how those expectations are changing. The complete survey results, including information sorted by company size and industry, are available to members of our site; CEOs and COOs interested in seeing the survey data are invited to apply for complimentary membership. To register, go here.

Regardless of company size, the central issue is pay-for-performance. ExpertCEO members typically have three components to their compensation – a base salary, a bonus and an equity stake in their company. In fact, 95% of our members who responded owned equity, with a mean stake of 8.5%.

With respect to bonus awards, the tricky question is how to measure performance. A recent posting on our site indicated that one member CEO’s board wanted to establish a bonus plan that triggered payments for the CEO and everyone else in the company based on a year-end cash balance target. And the pay formula was binary – pay 100% if the target is met and zero if it is not met. A number of comments on this approach agreed with the concept of targeting cash balance as the primary performance criteria during these difficult times. However, the “all or nothing” approach is unusual and will over-emphasize small accounting and reporting nuances at the end of the year. A more realistic approach might be a decelerating formula (e.g. pay 80% of the bonus if the target is 90% of the goal) and a threshold of a zero payment at, say 75% of target.

Other members described incentive compensation plans that substitute equity, in the form of options, for cash payments – another mechanism to conserve cash, and a very reasonable concept when cash is king. Simple in concept, BUT incredibly difficult in execution, when the liquidation preferences of many venture-backed companies are far higher than the value of the company, and the value of the options is questionable.

When a company is sold, liquidation preferences entitle certain (typically preferred) shareholders to receive fixed dollar returns before other (usually common) shareholders receive any payment; if the invested capital exceeds the purchase price, common stock and options turn out to be worthless securities. If the recession continues for a long period of time, these challenges will be increasingly relevant, as cash runs low and M&A exits are either infeasible or completed at valuations very low relative to the equity preferences in the company.

Executive compensation is always a delicate matter, but rarely more so than it is likely to be until economic conditions begin to turn around. CEOs need to feel comfortable their salaries and bonus targets are ‘in the zone’; calculating equitable and ‘market’ pay packages for their executive staff is another challenge ExpertCEO members are talking about. In response to numerous requests, we will be conducting a similar survey by VP function/company size/industry, to gather and share data members have told us they’d find useful. If you’re a CEO but not yet a member and want to participate, apply for membership today and help spread the word to other corporate leaders you believe would benefit from participation in this unique forum.