Incentive Pay Models at Privately Held and Nonprofit Organizations

Public company executive pay with seemingly excessive stock grants often occupies the news limelight and sets the standard for what people think about incentive compensation. However, the number of US public companies is a fraction of the amount of private companies and nonprofits. It is important for board members and other stakeholders to understand how private companies and nonprofits use various incentive models to create compelling executive pay packages, even without a publicly traded stock. The findings from the July 2021 Incentive Pay Practices Surveys published by Compensation Advisory Partners (CAP) and WorldatWork provide useful design parameters for consideration.

Private Company and Nonprofit Pay Models

Executive compensation is composed of three main components: base salary, short-term or annual incentives (STIs), and long-term incentives (LTIs). The public company executive pay model emphasizes incentive-based pay, including annual bonus and equity incentives. In public companies, LTIs are the largest component of executive compensation. Public company pay positioning often targets the competitive median, with the company’s stock price performance driving pay results.

In contrast, private companies and nonprofits focus on cash compensation, with private companies emphasizing base salary and annual incentives, and nonprofits emphasizing salary and benefits. As a result, cash pay positioning is often above median, with low (or sometimes no) long-term incentive opportunity. However, the trend to offer more incentive-based compensation is increasing as noted in the CAP-WorldatWork biannual surveys of incentive pay practices at private companies and nonprofit organizations.

Nearly all private companies offer short-term incentives, including goal-based annual incentive plans, spot awards, discretionary bonuses, and profit-sharing plans. Median spending on STIs in 2021 is projected to be 7 percent of operating profit which is the same percentage spend as public companies. Spending for STI plans continues to increase each year for reasons such as:

• Participation has broadened to include more employees

• Labor markets have tightened with increased competition for talent

• Economic performance is bouncing back to pre-COVID levels

Approximately 6 out of 10 private companies offer an LTI program, with three-year, cash-based performance awards being the most prevalent vehicle. Private companies offer LTIs primarily as an executive retention tool, but other goals include aligning executives’ incentives with the owners’ long-term goals and competing for talent with other employers. The majority of private companies grant LTIs on an annual basis with 3-year vesting, and typically share 15% or less of total economic value with their employees.

The choice of LTI vehicle depends on company strategy. Long-term cash plans are favored by companies operating as going concerns or those in the midst of a turnaround. Real equity is favored by start-ups and high-growth companies, private equity-owned firms, and those moving toward a value-realizing event, such as a sale or initial public offering. Phantom equity is often used by companies that may have a value-realizing event in the future, or that may wish to transfer ownership in the future for succession-planning purposes.

On the nonprofit side, over 80 percent of organizations offer short-term incentives in 2021, the highest level reported in our survey’s 14-year history. Median nonprofit spending on short-term incentives is estimated at 4 percent of operating budget for 2021. Nonprofit organizations have a more holistic performance measurement framework than for-profit companies, with most using four to six measures over all categories of financial; operational; environmental, social, and governance; and individual goals. Only about 2 in 10 organizations report using LTIs, including cash-based performance awards and nonqualified deferred compensation.

In addition to different pay models from public company peers, private companies and nonprofits have unique executive pay benchmarking considerations. Public companies typically focus on the pay levels and practices of other similar public companies. Private companies and nonprofits need to carefully define their markets for talent before benchmarking executive compensation. An organization’s market for executive talent should be defined to include frequent recruitment sources or market competitors. A large private company that competes with publicly traded companies may include those firms in its market for talent. Similarly, many nonprofits hire from both the for-profit and nonprofit sectors. As a result, benchmarking data may be drawn from different sectors.

Communication

Long-term incentives are the most challenging component of executive compensation for private companies. If LTIs are not well communicated to executives, they can undervalue the incentives. This creates an unfortunate situation where a private company’s owners have invested time and money in providing a competitive LTI opportunity, but the executives do not value the LTI as highly as the company’s owners intended. Since LTIs at private companies are most often reserved for executives, a focused communication plan is advised including both in-person meetings and written plan documentation, and an interactive LTI calculator. The calculator allows executives to model their LTI payouts under different performance scenarios and understand their wealth-accumulation opportunities. 

Nonprofit organizations also benefit from clear and comprehensive communication of their executive pay programs and other workplace rewards. Nonprofits typically offer a more holistic compensation and rewards program that includes an emphasis on base salary, an annual incentive opportunity with a lower target value relative to for-profit organizations, competitive benefits programs, and defined contribution retirement plans. Nonprofit employment also offers executives satisfaction in advancing a worthy cause and other non-compensatory rewards, such as work flexibility, training opportunities, job rotations that expand skills, and a positive workplace culture.

Private and nonprofit boards face unique challenges when it comes to executive compensation as benchmarking data is less available, and these organizations lack publicly traded stock. Boards need to place extra focus on communicating the unique value propositions to executives. Private companies and nonprofits can offer compelling executive compensation packages with extra work, thought, and creativity. These organizations have another huge selling point relative to publicly traded peers: their compensation programs are far less likely to end up as negative news stories!

Susan Schroeder is a partner in the Los Angeles office of Compensation Advisory Partners. She is a 2022 NACD Directorship 100 honoree.