Compensation Options for Small Business Management
Swanson, Robert D., Journal of Small Business Management
COMPENSATION OPTIONS FOR SMALL BUSINESS MANAGEMENT
Manager are the most important resource of any business, and countless hours have been spent considering ways to increase their effectiveness. Many feel that an effective compensation arrangement does more to promote management performance than any other action a relatively small but growing firm can take. For example, Peter Drucker points out that
...there is hardly a more powerful signal for managers than compensation and compensation structure. Its importance to them goes far beyond the economic meaning of moeny. It conveys to them the values of top management and their own worth within the management group. It expresses in clear and tangible form a man's position, rank, and recognition within the group....
Other factors, too, may have a significant effect on a manager's performance but the focus of this article is the matter of compensation options and compensation structure.
In the bestselling book Megatrends, it is said that many executives are now moving from large to relatively small firms because of the greater flexibility small firms afford in many areas, including management compensation plans. Management reward plans may be more effective in small firms than in large ones, because the effects of a manager's actions on profitability are more immediately apparent.
In designing a management reward system, straight bonus payments may be used, but more benefits may accrue to the firm if bonus systems are tied to the firm's stock. When management personnel have a considerable investment in their companies, they are more likely to identify strongly with the firm and its goals. When a firm goes through a difficult period, an executive or manager who owns company stock may make a short-run sacrifice in order to improve the firm's long-term position.
Except for qualified profit-sharing and retirement plans, the general case is that corporations cannot claim deductions for employee compensation plans unless the employee is required by law to declare the income. From a tax stand-point therefore, the executive and the corporation may prefer different plans. In any case, the type of plan selected should not be based upon the immediate tax effects on the corporation, but on longer range effects.
Discussed in this article are some currently popular forms of management compensation plans and the likely tax effects, advantages, and disadvantages of each type of plan for both the employer and the employee (see table 1).
TYPES OF COMPENSATION PLANS
A Source of Capital
Privately held companies can obtain capital for expansion and/or for acquiring retiring stockholder shares by using a system of stock bonuses or stock purchase by key employee. For growing companies this may be an important source of funds. One very successful large film, for example, pays its managers a percentage of the profits of the units they manage, but withholds a percentage of that payment for purchase of the company's stock. When the firm was young and growing, this was an important source of funds. This firm sells stock to the employees and repurchases it form them at book value. Repurchases before retirement are discouraged because the corporation has the option of repurchasing the stock over a ten-year period. Since many individuals have most of their savings in the firm's stock, this buyback option prevents them from becoming competititors. While this approach is somewhat rigid, it does force key employees into a savings plan which can be quite rewarding if the company does well.
With this type of plan employee achieve no tax advantages, because they pay for stock at its current price using after-tax dollars. The firm, however, can deduct the salaries and bonuses paid, and does not have to dealy its deduction for tax purpose as with some other stock plans. …