Avoid Surprises, And Work Out CEO Comp Plan Ahead of Time

Hiring a new CEO can be an expensive and daunting task. After an exhausting search to find good candidates, the board is still faced with yet another task-working out the details of the compensation offer.

The main components of the compensation offer are base pay, short-term bonus, qualified retirement plans, perquisites and the long-term benefit plan. There is a balance between base pay and long-term benefits that boards should understand. Base pay is not at-risk and guaranteed to be paid. The long-term benefit portion can be structured to serve as retention and reward mechanism, requiring longer-term employment, and perhaps performance too, in order for the CEO to receive the long-term benefit.

I am surprised that the typical practice is to present an offer to a new CEO and omit or elude the specifics of long-term benefit plan. The missing compensation component, the long-term benefit plan, often is only mentioned in language such as "to be determined later," or the very dangerous "to be provided in an amount that is offered at similar credit unions."

The reason for this omission may be linked to the complexity of determining the amount, the expense and the many provisions important to a long-term retirement benefit. If the credit union makes the effort to measure the long-term retirement benefit and include that benefit as part of a comprehensive compensation package offer for a new CEO, many surprises and potential disasters can be avoided. Boards without this expertise may do well to hire a consultant to guide them and assist in making the analytical measurements.


A Big Surprise

A common yet big surprise is to find that the accruals that have to be expensed are much larger than expected. With credit unions often struggling just to keep ROA positive, unexpected charges can ruin any CFO's day. On a couple of occasions we have seen boards realize they can't or won't afford the long-term benefit only to watch the CEO terminate shortly thereafter.

Each CEO candidate brings personal differences that alter the package a board may offer. For a young, aggressive, smart, industry-involved, career-climbing candidate, a board may consider shifting a good portion of the compensation to long-term retirement and condition its payment on employment at the time of retirement or other selected date. Contrast that with an older, experienced candidate who wants to live permanently in the same city where all his/her friends and family live. The need to provide a retention tool may be moot and perhaps the shift should be made more to base compensation and allocate a lesser amount to long-term benefits that are tied to performance metrics. While age discrimination is against the law, it is still important for the board to understand that each year it costs a lot more to provide a $1 at 65 for a 60-year-old than it costs to provide $1 at 65 to a 45-year-old. Understanding the candidate's intentions, interests and age will help the board to construct a comprehensive benefit offer that includes specifics about the long-term retirement component.


Consider This Scenario

For the analytics out there, here is an example of how big a surprise can be. Consider this situation:

New CEO: Age 55

Retirement benefit: 50% of final three year average compensation payable at age 62 annually for 20 years

Form of benefit: Lump sum equivalent of the retirement benefit computed using a 4% discount rate

Current base compensation: $200,000

If we use a salary scale of 4% (increases each year), the expected benefit at 62 is $1.7 million and the first year's annual expense to provide this is approximately $195,000. This almost doubles the expense for base compensation! Because of the arcane nature of these benefits, the board will do well to hire a qualified consultant who the board can trust to help them structure the long-term benefit as a comprehensive piece of the total compensation offer. With such expertise, the board can design a long-term piece that will serve to attract, reward and retain their new CEO.

The importance of the long-term benefit component should not be deferred until the CEO is in her/his office. By agreeing to the details of all the compensation pieces prior to employment, the board and the CEO will prevent hours of debate to develop the benefit in the future. All parties will understand, appreciate and expect the full expense of the CEO's total compensation.



Kevin W. Mahan is president/actuary of CUBED, Credit Union Board Executive Diligence, Pasadena, Calif., and has more than 10 years' experience advising CUs on proper implemetation of long-term benefit plans. Mr. Mahan can be reached at (626) 486-0161, ext. 334.