Compensation: disclosure urged for bonus formulas.

• Author: Marshall, Jeffrey
• Position: BusinessBriefs - Tips from compensation expert Bruce Ellig - Brief Article

Compensation expert Bruce Ellig has a suggestion for companies seeking to practice good governance at bonus season: that they disclose all pertinent facts about their bonus payments. Specifically, he suggests disclosing the formulas used to determine the bonuses, and offers this advice:

* Many companies traditionally have used "net income" (income after taxes)--a formula that encouraged some to overstate revenue and understate expenses. It is important to beware of companies that use EBITDA (earnings before interest, taxes, depreciation and amortization). Almost as bad is the use of EBIT. These formulas do not hold the executives accountable for debt (interest), changes in retained earnings income (after taxes and paid dividends), capital investments (depreciation) and acquisition costs (amortization of goodwill).

* If some form of economic profit is used (such as net income less the cost of capital--both debt and equity), is the formula appropriate in terms of the current cost of capital? Low interest rates and dividends (plus a modest risk premium) will generate a higher return...