Executive Compensation: Unique Challenges and Strategies for Creating Wealth as an Executive

Executives in today’s world face an increasing level of complexity when it comes to their compensation. Often executive compensation packages are heavily weighted toward equity and deferred incentives, each with its own set of opportunities and challenges when it comes to optimizing for your goals. Effectively navigating these requires an intentional, thoughtful, and proactive approach to maximize value and minimize risk. 

In this guide we’ll:

• Break down the building blocks of executive wealth creation 
• Examine unique obstacles executives face in managing their financial lives
• Provide actionable strategies to implement 

Our goal is to give you a clear roadmap for taking control of your financial future despite the complexities you may face.

Building Blocks of Executive Compensation

Executives typically receive a significant portion of their compensation in some form of equity, but there are other components at play as well. Understanding the types of executive compensation and the related tax consequences is essential for making informed decisions and optimizing outcomes. Common forms of executive compensation include:

• Base Salary and Bonus
• Non-Qualified or Incentive Stock Options
• Restricted Stock Units (RSUs) or Shares (Read more on RSUs here) 
• Employee Stock Purchase Plans (ESPP)
• Employee Stock Ownership Plans (ESOP)
• Stock Appreciation Rights (SAR)
• Phantom Stock
• Performance-based Shares and Awards
• Time-based Awards (LTIP, STIP)
• Deferred Compensation Plans

Each element has distinct features, vesting schedules, and tax implications, making it vital to tailor strategies to your specific situation.

Challenges Faced by Executives

Making the most of compensation as an executive is unique in its complexity due to a variety of factors, and often the interconnected nature of compensation elements only compounds over time. As careers progress, complexity grows, creating more need for a process that ties everything together and brings you clarity.

Busy schedules lead to time constraints

Executives are busy, often focusing almost exclusively (rightfully so) on their careers and business while deferring personal financial matters, sometimes indefinitely. These time constraints can contribute to missed opportunities for tax optimization, inadequate diversification of assets, and a reactive rather than proactive approach to finances. The irony is that those with the most complex financial situations often have the least time to properly manage them.

Risk from equity concentration increases over time

Executive compensation is heavily weighted towards equity, which often introduces significant upside opportunity that comes with inherent risks. Over time, dependence on the performance of the stock in a single company can introduce risk that has effects beyond just the numbers, potentially affecting life goals, retirement timing, and other career decisions.

Diversification and liquidity can be difficult to achieve

We often see executives with the tendency for a company stock concentration to build up, leading to a lack of portfolio diversification and, potentially, illiquidity. The psychological attachment to company stock, combined with regulatory restrictions and tax considerations, can make diversification feel overwhelming. Without adequate marketability and liquidity outside of company stock, executives may find limited options to use their wealth when desired.

Decision complexity from equity compensation

Executives need to make complex decisions regarding equity compensation, including when and how to exercise options and managing tax consequences and holding periods. Each decision has multiple variables to consider: current stock price, future price expectations, tax implications, cash flow needs, and overall portfolio balance. The timing of these decisions can have a big impact on the long-term financial picture, yet they often must be made under time pressure with incomplete information about future market conditions and personal circumstances.

Transaction restrictions

Regulatory and company-imposed restrictions on holding and trading company stock require specialized advice and careful planning.

Executive Compensation Opportunities and Strategies to Consider

Here are some of the decision points to consider in a process focused on maximizing the value of your compensation program:

• Develop a Diversification Plan: Evaluate whether to hold company stock or diversify into other assets and set targets for reducing company stock exposure over time to protect your wealth. Each situation is different, and while rules of thumb can be helpful, your own goals and purposes should play a big role in these decisions.
• When and How to Exercise: Decide when and how to exercise stock options based on market conditions, personal cash flow needs, and tax implications. Putting a rules-based plan in place will take the guesswork out of these choices.
• Managing Growing Concentration Risk: Monitor your overall exposure to company stock and implement strategies to manage risk as your holdings grow. Avoid the temptation to ignore this one!
• Implement a Tax Strategy: Proactively plan for tax events related to exercises, vesting, and sales. Assess tax implications and use a multi-year forecast to set expectations and avoid surprises.
• Review Holding Periods for Optimal Tax Treatment: Understand required holding periods for favorable tax treatment, such as long-term capital gains.
• Optional Tax Elections: Explore optional tax elections like Section 83(b) that may improve your after-tax outcomes.
• Regularly Review Agreements: Stay informed about the terms of your employment and compensation agreements, especially during transitions or corporate events.
• Monitor Liquidity Needs: Ensure you have adequate liquidity for personal goals and unexpected expenses, independent of company stock performance.
• Stay Informed: Keep up with changes in tax law, company policies, and market conditions that may impact your compensation and wealth plan.

As you can see, there’s little room to “set it and forget it,” and managing your comp should be a dynamic process that requires balancing opportunity with risk. The unique challenges facing executives, from time constraints and complex agreements to concentration risk and regulatory restrictions, demand attention and effort. By understanding the forms of compensation available to you, recognizing their interconnected nature, and implementing a disciplined strategy that connects with your vision, you can make a big difference in how comp outcomes support your long-term goals. The key is to start. Get started wherever you are in the process, plan proactively, don’t shy away from the complexity of your situation, and leverage the expertise available to you.

The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor. The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.  For additional information, please visit: http://verum.stg2.lazarushost.com/disclosures/