“The rich are different than you and me,” F. Scott Fitzgerald wrote. That truism can be applied to the differences between employees and executives today, and perhaps nowhere is the gap more conspicuous than in the benefits and perks executives receive while they’re working for a company – and continue to receive once they retire. Moreover, most companies hide these perks. The time has come, writes this author, to open up and disclose.
It is an irony not lost on corporate gadflies that the benefits paid to the group of employees most able to afford to pay for them – executives – are higher than for any other group of employees. In many cases, this situation has come to pass not because of money, but because of stature. Benefits, like salary, reflect the position of executives. If their total compensation is higher than for all other groups of employees, then benefit provision should be correspondingly higher. There is a kind of logic to this explanation. But there is also a kind of anti-logic, too. Providing benefits to those most able to purchase such services themselves would appear to go against common sense.
There are a number of approaches to providing benefits. These include:
- No benefits, that dictates that executives are paid enough to purchase any goods or services without any company funding, and are free to do so.
- Basic benefit provision, mirroring that provided throughout the company’s ranks, provides the basic welfare benefits full-time employees receive, but no top-up or special perquisites.
- Full executive benefits that provides the full suite of executive level benefits and perks.
- Cafeteria benefits that allow the basic benefit provision to be topped up with a few executive-level benefits that might be considered either appropriate or necessary from a business use point of view.
As with many other things, the appropriate approach for most executives, boards and compensation committees is something of a compromise. But the exact approach adopted will depend very much on a company’s values and the board’s compensation philosophy.
The two most important and controversial issues that surround executive benefits are insufficient disclosure and elitism. This article will examine both of these issues and suggest what companies should do to eliminate practices that make the issues flashpoints for heated discussion.
Over 10 years have passed since U.S. disclosure regulations were made into law, and benefit practice has changed considerably since then. Still, however, the current disclosure rules are ineffective. This situation has led to two developments. One is that the SEC is seriously considering completely revamping the way benefits are disclosed. The second is that, in many of its investigations today the IRS is targeting the high cost and poor disclosure of benefits provision.
At present, SEC regulations require that a proxy statement disclose benefits under two columns in the summary compensation table that appears in proxy statements: “other annual compensation,” and “all other compensation.” Several additional tables are required to disclose retirement benefits.
“Other annual compensation” must include:
The dollar value of other annual compensation not properly categorized as salary or bonus, as follows:
Perquisites and other personal benefits, securities or property, unless the aggregate amount of such compensation is the lesser of either $50,000 or 10% of the total of annual salary and bonus reported for the named executive;
Above-market or preferential earnings on restricted stock, options, SARs or deferred compensation paid during the fiscal year or payable during that period but deferred at the election of the named executive officer; Earnings on long-term incentive plan compensation paid during the fiscal year or payable during that period but deferred at the election of the named executive officer; Amounts reimbursed during the fiscal year for the payment of taxes; and
The dollar value of the difference between the price paid by a named executive officer for any security of the registrant or its subsidiaries purchased from the registrant or its subsidiaries (through deferral of salary or bonus, or otherwise), and the fair market value of such security at the date of purchase, unless that discount is available generally, either to all security holders or to all salaried employees of the registrant.
The column entitled “all other compensation” must contain all other items that have not already been included in other annual compensation. These include:
The amount paid, payable or accrued to any named executive officer pursuant to a plan or arrangement in connection with:
The resignation, retirement or any other termination of such executive officer’s employment with the registrant and its subsidiaries; or
A change in control of the registrant or a change in the executive officer’s responsibilities following such a change in control;
The dollar value of above-market or preferential amounts earned on restricted stock, options, SARs or deferred compensation during the fiscal year, or calculated with respect to that period, except that if such amounts are paid during the period, or payable during the period but deferred at the election of a named executive officer, this information shall be reported as Other Annual Compensation;
The dollar value of amounts earned on long-term incentive plan compensation during the fiscal year, or calculated with respect to that period, except that if such amounts are paid during that period, or payable during that period at the election of the named executive officer, this information shall be reported as Other Annual Compensation;
Annual registrant contributions or other allocations to vested and unvested defined contribution plans; and
The dollar value of any insurance premiums paid by, or on behalf of, the registrant during the covered fiscal year with respect to term life insurance for the benefit of a named executive officer, and, if there is any arrangement or understanding, whether formal or informal, that such executive officer has or will receive or be allocated an interest in any cash surrender value under the insurance policy, either:
The full dollar value of the remainder of the premiums paid by, or on behalf of, the registrant; or
If the premiums will be refunded to the registrant on termination of the policy, the dollar value of the benefit to the executive officer of the remainder of the premium paid by, or on behalf of, the registrant during the fiscal year. The benefit shall be determined for the period, projected on an actuarial basis, between payment of the premium and the refund.
Further disclosure is required to describe the potential benefits from qualified and non-qualified retirement benefit schemes.
Defined Benefitor Actuarial Plan disclosure
For any defined benefit or actuarial plan under which benefits are determined primarily by final compensation (or average final compensation) and years of service, provide a separate Pension Plan Table showing estimated annual benefits payable upon retirement (including amounts attributable to any defined benefit supplementary or excess pension award plans) in specified compensation and years of service classifications. Immediately following the table, the registrant shall disclose:
The compensation covered by the plan(s), including the relationship of such covered compensation to the annual compensation reported in the Summary Compensation Table, and state the current compensation covered by the plan for any named executive officer whose covered compensation differs substantially (by more than 10 percent) from that set forth in the annual compensation columns of the Summary Compensation Table;
The estimated credited years of service for each of the named executive officers; and a statement as to the basis upon which benefits are computed (e.g., straight life annuity amounts), and whether or not the benefits listed in the Pension Plan Table are subject to any deduction for Social Security or other offset amounts.
Alternative Pension Plan Disclosure. For any defined benefit or actuarial plan under which benefits are not determined primarily by final compensation (or average final compensation) and years of service, the registrant shall state in narrative form:
(i) The formula by which benefits are determined; and
(ii) The estimated annual benefits payable upon retirement at normal retirement age for each of the named executive officers.
The disclosure requirements create several problems.
First of all, the “get out clause” for disclosures under “other annual compensation” appears wholly inappropriate. There seems no real justification for allowing benefits “valued” at less than $50,000 or 10 percent of salary and bonus to be ignored. The SEC did not originally have this clause in place, but added it following complaints about the additional burdens of compliance that the disclosure of all benefits would bring.
Secondly, the disclosures for both “other annual compensation” and “all other compensation” call for the “dollar value” of benefits, in other words, their value to the executive or their taxable value. Such a valuation, however, does not represent the cost of such benefits – a figure that would be of great interest to most stockholders and indeed most board members.
Regarding the disclosure of retirement benefits, again, the SEC regulations ignore the potential cost of providing these benefits, the figure that boards and stockholders are most interested in. Furthermore, it is only under the “Alternative Pension Plan Disclosure” that the company needs to give any readily available estimate of the level of retirement benefit. Under the normal disclosure regulations, figures must be estimated and crosschecked from at least four separate tables in order to come to any accurate estimate of potential benefits under the schemes. Lastly, the only piece of disclosure – apart from filing the plan rules themselves-that covers voluntary deferred compensation plans is the disclosure of above market rates of interest on invested deferred compensation in the ‘all other compensation’ column.
The disclosures relating to supplemental executive retirement plans (SERPS) and other deferred income plans are wholly inadequate for assessing the potential benefits an executive will receive and estimating their cost to the company. These disclosures are all that stockholders have available. If this is also the only information that is available to the board and to management, there is a serious information gap that needs to be closed. These types of pension plans – often referred to by critics as stealth compensation – are those that are presently under the most scrutiny. They are also likely to be the target of legal reform. Proposals to tighten the rules surrounding SERPs and non-qualified deferred compensation (NQDC) plans were dropped from the Jobs and Growth Tax Relief Act of 2003, but they have been the subject of many Congressional reports and other prospective bills ever since, though none that have actually been signed into law.
There can hardly be a better example of the problems that inadequate disclosure of benefits can bring than the following fictitious illustration. The well-respected, long-tenured CEO of Widget Inc, John Doe, was due to retire and the board wanted to give him a special mega-award of cash and stock in recognition of his great performance and leadership. The CEO demurred and suggested that, instead, the board continue the full suite of his current executive benefits in to his retirement. The board agreed. During this period, John Doe was being divorced by his wife. In a submission to the court, his wife indicated – by providing a complete list of the benefits he was eligible for – what the divorce settlement would need to be in order for her to be kept in the manner to which she was accustomed during her marriage. This submission was filed with the court and immediately picked up by the Daily Broadsheet, which published full details of the benefits Doe enjoyed and to be enjoyed throughout his retirement. These included: the private use of Widget Inc.’s corporate aircraft, an $80,000 per month New York apartment, court side seats for the New York Knicks and the U.S. Open, box seats at Red Sox and Yankees baseball games, country club fees, security services, restaurant bills, company cars and financial planning services. Doe’s personal standing as one of the world’s most admired CEOs declined significantly, as did Widget Inc.’s own reputation.
The board did nothing, as it had signed a contract with Doe guaranteeing him these benefits in perpetuity. Eventually Doe, in order to save the company from further harm, publicly announced that from now on he would pay for the benefits himself. Critics continued to harp on the subject. “It was not so much the provision of the benefits,” they said, “After all, everyone made money during John’s tenure. It was just that we didn’t know….”
It is very rare for companies to describe the benefits that they provide to their executives, so when a compensation committee does give some information about their executive benefit package, stockholders are grateful and impressed even where it contains elements that might be considered unnecessary. The following examples illustrate this well.
“The compensation committee is responsible for: executive benefits, including automobile and club allowances, professional association fees, key personnel insurance, individual security measures and assistance in personal asset management and other benefits calculated to advance the company’s business.”
(North Fork Ban corporation – 2004 Proxy Statement)
The executive benefit package provides: “access to the Company’s plane for business purposes and, in some cases, personal usage; company provided leased vehicles, first class air travel, financial services allowance and an annual physical exam.” (Boeing – 2004 Proxy Statement)
While it is rare for compensation reports to describe benefits packages in this much detail, it is rarer still for compensation committees to decide to illustrate the make up of payments that are disclosed under “other annual compensation” and “all other compensation” in the Summary Compensation Table. When it does happen, it is a clear demonstration of a committee attempting to mitigate any criticism of excessive benefits before it even happens. Tables in Honeywell’s 2004 proxy statement (Please see page 8) provide information and data well in excess of statutory requirements, and delineate some benefits that stockholders might prefer not to fund. But at least stockholders know what they are paying for. This level of disclosure is exemplary.
The second major problem with benefits, elitism, is one that can only be addressed as part of a company’s compensation philosophy. When the subject of executive benefits comes up, comments can be overheard from employees such as, “It’s not about the money, it’s the principle.” Or, “Can’t they pay for it themselves?” Or, “It just makes out that they’re special and we’re not.” Such resentment is bad for employee morale and employee relations. For example, the stark difference between staff at Delta Airlines and its executives was amply illustrated when, following long negotiations to cut staff pensions and other benefits, it was revealed that the executives’ SERP benefits had been fully funded using a protected trust. ‘Ring fencing’ one group of employees’ extremely generous pension provisions while economizing on another groups’ modest retirement income is not the best way to improve employee morale.
While the following example is fictitious, it presents situations that cannot be unknown in corporate North America.
Employee relations; Widget Inc.
All employees were moved to 401(k) plan pension provision, except for executives who remained part of a non-qualified defined benefit final salary plan. In the same year, all employees were asked to make contributions to help cover the cost of the HMO medical insurance. Those with families were asked to contribute 50 percent of the costs, except for executives who continued to receive a fully subsidized medical, dental and vision plan, which continued coverage for them and their spouses and dependants in to retirement and for spouses following their death.
Subsidized meals in the staff cafeteria were ended and full cost meals were introduced. Free coffee and beverage dispensers were replaced with vending machines. The executive dining room continued to provide free meals to executives whether or not they were joined by a business partner or client
The July 4th staff picnic was cancelled as a cost containment measure. The two week Board and Senior Management Retreat was booked for Hawaii. Spouses and partners were invited.
Employee attrition and turnover rates have risen so dramatically that customer service and quality problems are cutting into revenue and earnings projections. Widget’s market share is down by 80 percent. A general recovery in the widget industry has allowed Widget’s main competitor, Gizmo Corp., to capitalize on Widget’s quality problems and capture its lost market share.
Some companies that want to eliminate the perception of elitism have been steadily dropping executive-style perks from their compensation packages. Between 2000 and 2003, for example, Bank One, which merged with JP Morgan Chase in 2004, eliminated or substantially limited various special pay or perquisite programs for its executive officers. For example, it eliminated:
- subsidies for club memberships, automobiles and similar perquisites;
- split-dollar insurance programs;
- corporate matching 401(k) contributions for senior management and highly compensated employees;
- special executive severance policies, and
- reduced covered 401(k) earnings to the maximum qualified plan limit.
In addition, Bank One terminated its supplemental executive retirement plan (“SERP”). The bank “secured agreements from current executives to forego SERP benefits, and has no intention in the future to grant extraordinary pension benefits to executive officers pursuant to any employment agreements or the SERP, and has no intention to adopt any new plan that would provide for the granting of extraordinary pension benefits to its executive officers.”
A number of other companies indicate very clearly that they do not provide special benefits or perquisites of any kind to executives. These include Kinder Morgan, Cisco Systems, and Autodesk. A number of other companies disclose that supplemental retirement benefits have been frozen or terminated in some way. This is the case at Bank of America and Exelon. But these companies and the others like them represent a tiny minority. By far the majority of companies provide benefits at levels commensurate with general executive compensation levels, justifying the practice by using the logic/anti-logic argument outlined at the beginning of this article. It is a situation that is unlikely to change quickly. However, that even a few companies have taken steps to end special benefit provision – as opposed to those that have never engaged in it – must surely be heartening.
The final word on perquisites will be left to American International Group, whose 2004 proxy statement includes the passage below. The disclosures are welcome, and one would hope that many other companies will follow this example when disclosing executive benefits.
In order to facilitate the performance of their management responsibilities, AIG provides to Messrs. Greenberg, Kanak, Smith, Sullivan and Tseau to mobiles and drivers and to these individuals and other officers and employees the use of a yacht and corporate air craft, club memberships, recreational opportunities and clerical and investment management services. These facilities are provided for use for business purposes and the costs thereof are considered ordinary and necessary business expenses of AIG. Any personal benefit any of these persons may have derived from the use of these facilities or from the services provided is regarded as incidental and the amount thereof has therefore not been included in the compensation shown in the Summary Compensation Table.
This article has been adapted from a chapter on Executive Benefits, part of a book on executive and board compensation by Paul Hodgson. Reprinted with permission from the upcoming Board Perspectives:Building Value Through Executive Compensation owned and copyrighted by CCH INCORPORATED. All Rights Reserved. No further reproduction or distribution is permitted without prior written permission from CCH