Taking executive compensation public.

• Author: Harvey, Ryan
• Position: Private companies

Initial public offerings have been rising significantly this year, increasing 317 percent in the first two quarters over the same period in 2009. This trend is expected to continue as more private companies prepare for market debuts. They should not underestimate the importance of making necessary changes in their executive compensation programs.

At public companies, executive pay programs are subject to the scrutiny of shareholders who often have different expectations than private investors. Market perceptions of a company's capacity to retain and motivate executives are crucial to the success of an IPO. To be competitive in the public arena, most private companies' compensation programs require significant restructuring.

Early planning is essential if companies are to act in time to demonstrate to investors the desired alignment between compensation and shareholder value before IPOs are issued. Among those involved in the planning process are human resources executives, who recommend program changes to the board of directors, and financial executives, who provide input on financial metrics and prepare for impacts on tax planning, accounting and stock-plan management.

Key areas for consideration include:

* Competitive compensation opportunities. The best way to assure that salaries and performance incentives are competitive with public company norms is to select an industry peer group of companies of similar size and complexity that have similar executive talent needs. Analysis of peer-group compensation levels and practices will suggest changes necessary to keep executive talent from being lured away by these competitors.

IPO companies must show investors strong links between pay and performance. This can be accomplished by tying incentives to the achievement of key performance goals represented by financial metrics. These metrics should be chosen as those most likely to realize business strategies formulated to propel the rapid growth that investors want. The resulting programs can have significant tax and accounting implications.

* Long-term incentive plan (LTI) design. No pay element is more critical for creating sustained shareholder value. The most commonly used vehicles for LTIs are stock options, restricted shares and performance shares (shares earned commensurate with performance over a set period). Though most IPO companies use a mix of these three vehicles, stock options are most heavily weighted.

Without well-structured LTIs...