Just rewards: it's not so much what someone is worth as what you want a pay package to accomplish that determines executive compensation

Folio: The Magazine for Magazine Management, Nov 1, 1990 by James B. Kobak

* Options to buy in the future: An option can result in great wealth for an executive at times, but it doesn't have the same psychological effect as actually owning stock.

* Phantom stock: Although not actual shares in the company, phantom stock behaves the same way by providing dividends, and when an executive leaves, his shares are bought back at the current value or at the value to which they have increased since they were issued.

* Performance units: Like phantom stock, these are based on the company's future increased value. They usually do not offer dividends, and the change in value is determined over a relatively short period (two or three years) before a new period is started.

The psychological effect of owning real stock is, of course, very great. Selling an executive part of the company, which provides the biggest psychological boost, can be done immediately or over time. There can be a question about the price at which the stock is sold. A valuation may be required. Since only a small minority is sold to any one person, a minority discount that might range up to 50 percent of the actual value is applied. And since the owner or the company usually has an option to buy it back, there can also be a marketability discount of 10 to 15 percent. It might also be nonvoting. The worry is that if the price is too low, the IRS might consider that part of the discount is compensation.

Selling stock

Companies often offer to sell stock to an executive, but the shares are sold over a period--say 1 percent after the first year, another 1 percent after three years, and another 1 percent after five years. The object, obviously, is to help make sure the executive stays. The company may also help with the financing of the purchase through a loan, or might help make arrangements with a bank.

Some companies make a gift of part of the company--although most, for psychological reasons, prefer their executives to buy the stock rather than get it free. A gift might also arouse the curiosity of the IRS as being additional compensation.

A word of caution: One major purpose of executive compensation is to make it hard for executives to leave. If profit and stock plans are not very carefully drawn, you might achieve just the opposite effect--and force them out.

Payouts from such plans should vest over a period of years--and should depend on how long the executive has been with the company. Installment payments prior to a certain age also help.

Again, we might stop and ask what the real purpose of each part of the executive compensation package is, and what the end result might be. To oversimplify a bit, there are basically nine methods of compensating employees: salary, bonus, commission, etc.; payroll taxes; medical plans, life insurance, savings plans; pension plan; profit-sharing plan; perquisites; psychological perks; profit-improvement plans; and piece of the action plans. The objectives can fit into five major categories: fair pay; services rendered; security; get and keep people; and increase the value of the company.