Four-Part Survey on Short-Term and Long-Term Incentive Pay Practices at Public, Private, Nonprofit and Government Organizations.

Changes to short-term incentives (STIs) prompted by the global pandemic/economy are largely temporary, and some organizations cite the pandemic as the reason for modifying long-term incentives (LTIs). These findings are captured in the “2021 Incentive Pay Practices Study” of publicly traded, privately held, nonprofit, and government organizations conducted by Compensation Advisory Partners (CAP) in partnership with WorldatWork. The four-part survey provides a sweeping overview of approaches to incentive pay, including types of STI plans; annual incentive plan (AIP) measures, eligibility, targets, and payout frequency; long-term incentive (LTI) prevalence; incentive plan budgets (actual and estimated); and more.

Sample Findings

Publicly Traded Companies

• 34% of public companies added or modified their STI plans for 2021 with 26% of the changes due to the global pandemic/economy, and of those changes, 83% are temporary.
• 92% of public companies grant LTIs on an annual basis, and 66% vest LTI awards over three years.
• 13% of public companies identify diversity, equity and inclusion (DEI) initiatives as one of their STI performance measures to determine AIP payouts, in addition to financial, individual, and operational measures.

Privately Held Companies

• 37% of privately held companies added or modified their STI plans for 2021 with 29% of the changes due to the global pandemic/economy, and of those changes, 82% are temporary.
• Use of LTIs is down at private companies: 51% in 2021, down from norms in the low 60% range since 2013.

Nonprofits

• Short-term incentive prevalence at nonprofits increased in 2021 to 82%, the highest level reported in this survey’s history.
• Nonprofits, including large institutions, place less emphasis on profitability performance measures than for-profits, 46% compared to 72% (publicly traded companies) and 74% (private companies).
• About one-fifth (18%) of nonprofits have LTIs, compared to 94% of publicly traded companies and 51% of private companies.

Government Organizations

• STI use at government organizations reached 58% in 2021, up from 44% in 2019.
• Government organizations that offer LTIs (10%) do so through nonqualified deferred compensation programs.

“We’ve done this survey since 2007, and with each iteration we’ve seen incentives become more prevalent and offered to a broader range of employees,” said Bonnie Schindler, CECP and a principal at CAP. “Organizations are spending more on this component of compensation, and we expect to see incentives continue to be emphasized into the foreseeable future to align pay with performance.”

“It’s a white-hot labor market, and employers are struggling to find, engage and retain top-performing employees,” said Sue Holloway CCP, CECP, Director, Executive Compensation Strategy, WorldatWork. “It behooves every employer—public, private, nonprofit, and government alike—to get up to speed quickly and benchmark their incentive plans against all sectors because job candidates are gauging them to help determine their next career move.”

Methodology

WorldatWork collected survey data for the four-part survey during an 18-day period starting 3/4/21. The survey report is based on 1,226 responses across the four sectors: publicly traded; privately held; nonprofit; and government organizations. The demographics of the survey sample and the respondents are similar to the WorldatWork membership as a whole. The typical WorldatWork member works at the managerial level or higher in the headquarters of a large company in North America.

The full results of the Incentive Pay Practices surveys are available to WorldatWork members at Incentive Pay Practices (worldatwork.org)

For questions or more information, please contact:

Bertha Masuda
Partner
[email protected]
310-541-6233

Bonnie Schindler
Principal
[email protected]
847-636-8919

Susan Schroeder
Partner
[email protected]
310-426-2340

On January 19, 2021, the Internal Revenue Service (IRS) published the final regulations of the Internal Revenue Code (IRC) Section 4960 of the Tax Cuts and Jobs Act of December 2017. Section 4960 imposes a 21 percent excise tax on an “applicable tax-exempt organization” (ATEO), or a related organization, if that ATEO pays (1) remuneration in excess of $1 million to a “covered employee,” one of the top five highest-paid employees at the organization, or (2) parachute payments in excess of three times the base salary of a covered employee. These regulations will apply for tax years starting after December 31, 2021. See the copy of the final regulations, which varied from the proposed regulations in a few minor ways, here.

A summary of the key take-aways from the final regulations and how they may impact executive compensation practices follows:

• No Grandfathering: The 21 percent excise tax under Section 4960 will apply to compensation that has been paid or becomes vested during taxable years starting after December 31, 2017, the year Section 4960 was passed. The IRS rejected proposals for grandfathering contracts existing before this date.
• Review Aggregate Compensation: ATEOs may pay covered employees through multiple entities of their organization or through “related organizations” (where the threshold for relatedness is 50 percent). Under the final regulations, the compensation a covered employee receives through all entities or related organizations is aggregated in the remuneration calculation. If this aggregate amount exceeds $1 million, the ATEO will pay a 21 percent excise tax.
• Once Covered, Always Covered Rule: Under this rule, once an individual has been identified as a “covered employee” of an ATEO, this status stays with them indefinitely, even after retiring from the ATEO. As a result, any backloaded arrangements to defer compensation to a covered employee shortly past the date of retirement is still subject to the $1 million cap. In addition, payment for service at a related ATEO is counted. As an example, suppose a former covered employee of a tax-exempt entity works for a related organization after such employee’s retirement from the prior entity. Future remuneration paid for service at the related organization would be subject to the $1 million cap.
• There are two exceptions to this rule: (1) nonexempt funds exception and (2) limited hours exception. These exceptions are meant to help ATEOs avoid paying the excise tax on behalf of their employees who provide them with limited services.
  • Under the “nonexempt funds” exception, an employee’s time spent providing service to the ATEO over the applicable and preceding year must not exceed 50 percent of their total service time to the related organizations during that same period.
  • Under the “limited hours” exception, an employee’s time spent providing services to the ATEO over the applicable year must be less than 10 percent of their total time for the related organizations during that same year.
• Special Timing Rule for Remuneration: This new rule states that deferred compensation must be included in the remuneration calculation the year it is vested (i.e., when the remuneration is no longer subject to a substantial risk of forfeiture), rather than the year it is paid out. For instance, if a covered employee is granted a $1 million dollar retention bonus that has a service requirement of five years, the bonus will be counted as remuneration in the fifth year. Alternatively, if the retention bonus vests ratably at $200,000 each year for five years, $200,000 will be counted as remuneration in each vesting year until the full retention bonus is fully vested.
• Remuneration Excludes Pay for Medical Services: The remuneration calculation disregards compensation that hospitals pay to doctors and nurses for medical services. Therefore, the “medical services” portion of compensation to a “covered employee,” such as Chief Surgeon, is not accounted for in the remuneration calculation. In contrast, compensation that is paid for an employee’s administrative services is included in the remuneration calculation.
• Split-Dollar Life Insurance Arrangements: Under the new regulations, ATEOs, especially those that are private foundations or Section 509(a)(3) supporting organizations, are cautioned from entering into split-dollar life insurance arrangements with their covered employees. Such loans to certain employees “may constitute an act of self-dealing under Section 4941 or an excess benefit transaction under Section 4958(c)(3).” The new regulations consider this type of compensation as a part of the renumeration calculation. De minimus loans, or loans under $10,000, are an exception.

Short-term, cash incentives continue to dominate the incentive-pay landscape at nonprofit/government organizations according to salary and compensation survey research released in May 2018 by WorldatWork in partnership with Vivient Consulting.

“U.S. nonprofit organizations continue to make significant use of short-term cash incentives to motivate and reward employees. Long-term incentive (LTI) use is still a little-used compensation element, but prevalence increased modestly in 2017 and may signal an emerging trend,” said Bonnie Schindler, partner and co-founder of Vivient Consulting.

Additional Key Findings from the WorldatWork-Vivient Survey

Nonprofit/Government Compensation Survey Results:

• Nonprofit and government organizations favor simplicity by offering a limited number of STI plans. Of the respondents, more than 75% reported having three or fewer STI plans in place.
• By far, the most common type of STI plan at nonprofit and government organizations continues to be an annual incentive plan (AIP). However, prevalence of AIPs dropped to 77% in 2017 from 86% in 2015

The compensation survey Incentive Pay Practices: Nonprofit/Government was conducted in December 2017 among WorldatWork members. The salary and pay survey is the third edition for nonprofit/government entities with the last report data released in 2015.

In the last few weeks, we’ve seen mainstream media highlight the competition for talent at tax-exempt organizations. The Wall Street Journal reported that CEO pay at tax-exempt organizations increased in aggregate by a third from 2011 levels. While this increase can be explained in part by the economic rebound of these organizations since the Great Financial Recession, there are larger factors at work.

Complexity and organization size, two main drivers of executive compensation in the for-profit world, apply to tax-exempt organizations as well. From a complexity standpoint, tax-exempt CEOs must simultaneously attend to multiple priorities and constituents. They have a tough balancing act managing multiple stakeholders’ interests to achieve the organization’s mission. This visible position must serve his or her community, court donors, navigate the political landscape, handle the press, and fiscally steward the organization. In contrast, Fortune 500 CEOs’ primary focus is to satisfy shareholders’ financial expectations (with other demands being subordinate). Further, the number of executives with the experience of successfully leading significantly-sized tax exempt organizations is limited. As a result, the talent pool is small, and the demand for them is fierce. For example, the Los Angeles Times just reported that the storied but financially struggling New York Philharmonic hired Deborah Borda as its new CEO with the expectation that she can sprinkle on it the “same magic” she did during her tenure at the Los Angeles Philharmonic.

The structure of compensation reflects this intense demand for talent, as well as the strategic planning and economics of these tax-exempt organizations. The typical tax-exempt CEO receives a base salary and a bonus opportunity, which is prevalent in three-quarters of such organizations according to Vivient Consulting’s survey. Some organizations also provide longer-term financial arrangements that serve as a retention hook and provide financial security in retirement. Most large tax-exempt organizations have multi-year strategic objectives (such as passing important legislation, multi-year capital campaigns, etc.) and want to focus their top executive on the extended time horizon required to create lasting legacies. However, unlike for-profit companies, there is no equity compensation available. As a result, long-term incentives need to be designed to reflect both mission and fiscal success, incorporating qualitative and qualitative measures that support these organization’s values and mission.

From a governance standpoint, we find that CEO pay at larger tax-exempt organizations is governed in an independent and structured process that mirrors that of for-profit companies. In our experience, independent Boards of Directors spend a significant amount of time and attention to the reasonableness, fairness, and pay-for-performance (defined more broadly to include the achievement of the organization’s mission) of CEO compensation. This is not surprising as sophisticated businessmen and women who sit on these organizations’ boards of directors bring their independence and expertise to the pay discussion. Further, the boards are careful to maintain good governance process over CEO pay decisions in order to maintain the “rebuttable presumption of reasonableness” and avoid IRS intermediate sanctions.

With increased demand for talent, we see more cross-over of executives and compensation practices between tax-exempt and for-profit organizations. Thoughtful compensation practices and programs grounded to the organization’s mission and economics can help retain and motivate these uniquely skilled executives.