Executive Compensation
Executive Compensation examines how boards set, govern, disclose, and tax the pay of senior leaders. The exam tests plan vehicles, peer benchmarking, compensation-committee process, and the statutes that constrain design-especially IRC Sections 162(m), 280G, and 409A.
Governance and benchmarking
An independent compensation committee sets philosophy, approves the peer group, and retains advisers under exchange listing standards and Rule 10C-1 independence factors. Peer groups should reflect industry, revenue, market cap, and geography; regression or a blended approach reduces size bias. Benchmark to median, with P75 used selectively for executive roles. Pay mix tilts toward variable and equity pay.
Plan design
Short-term incentives use threshold, target, and maximum payout levels tied to metrics such as revenue, EBITDA, or EPS. Long-term incentives include nonqualified stock options, incentive stock options, restricted stock units, performance stock units, and stock appreciation rights. PSUs may use relative TSR, EPS, or ROIC. Plans also set vesting, holding periods, stock ownership guidelines, and anti-hedging or anti-pledging policies. Change-in-control severance may be single- or double-trigger; double-trigger requires both a CIC and a qualifying termination.
Tax and securities rules
Section 162(m) limits public-company deductions to $1 million per covered employee; the performance-based exception was repealed for tax years beginning after 2017, subject to grandfathering. Section 409A governs nonqualified deferred compensation, including discounted options and some severance, and imposes a 20% additional tax plus interest. Section 280G treats payments exceeding three times the base amount as excess parachute payments; Section 4999 imposes a 20% excise tax, and the corporation loses the deduction. Dodd-Frank requires advisory say-on-pay votes and exchange-listing clawback policies under Rule 10D-1. ASC 718 governs accounting expense.
Worked example
An executive has base salary of $600,000, a target bonus of 100%, and a change-in-control severance of 2x base plus target bonus. Severance equals 2 x ($600,000 + $600,000) = $2.4 million. The five-year average W-2 base amount is $1.5 million, so three times the base amount is $4.5 million. Because $2.4 million is below $4.5 million, no excess parachute payment arises. If the severance were $5.0 million, the excess would be $500,000, the 20% excise tax would be $100,000, and the company would lose the deduction on the excess.
Traps that cost marks
Do not confuse the 162(m) deduction cap with 409A deferred-compensation rules. Do not treat say-on-pay as binding. Do not assume performance pay remains deductible after 2017. Do not apply 280G to the whole payment; only the excess over three times the base amount is penalized. Do not benchmark to a peer group without checking size and scope.