WITH SHAREHOLDERS AND OTHER KEY STAKEHOLDERS increasingly demanding executive compensation be linked to performance, companies are scrambling to ensure the total compensation package they offer is aligned to business goals.

Over the years, it’s been demonstrated that companies that invest in performance-based pay perform better than companies whose pay is not performance- based. According to data from Watson Wyatt Worldwide’s 2005 TSX/S&P CEO Pay Survey, on average, 60% of a CEO’s total compensation is somehow linked to company or individual performance. This percentage increases to more than 70% for the top 60 companies of the TSX/S&P.

While equity-based compensation(stock options or stock awards) has gone a long way in reinforcing and promoting a pay-for-performance philosophy, pension plans have until now been largely overlooked in the move to this model.

Tying performance to the pension of top executives is an appropriate response in the current environment, where corporate governance and public scrutiny towards executive compensation have highlighted other forms of compensation such as pension and some types of termination benefits. There are many compelling reasons to use an incentive-based supplementary executive retirement plan, or I-SERP:
• It ensures the company can afford the cost of the pension benefits it offers;
• It introduces a means to attract executives who are closer to retirement by improving their retirement package, while protecting shareholders’ interests;
• It reduces the financial impact of pension improvements, by postponing the cost and liability;
• It allows emerging companies to attract executives without jeopardizing their current financial position;
• It improves the global compensation tax effectiveness to the executive by enhancing retirement savings.

There are a number of elements that can be included in an I-SERP to ensure it is linked to performance. In the case of defined benefit plans, these can include crediting additional service by varying the number of years included in calculating pension benefits, with more years of credit with better performance. Another option is to improve the percentage credited per year of service.

Yet another approach is recognizing additional earnings in the benefits formula. That’s because an emerging company without a current SERP might introduce an I-SERP that recognizes earnings up to a certain limit. That limit would be removed with the achievement of key business objectives. The final approach could be to improve the features of the benefits payable.

For defined contribution I-SERPs, some of the elements include:
• Improving the percentage contributed to the account;
• Creating a defined contribution I-SERP where employer contributions would be entirely invested in
shares of the company or where the return would be linked to the company’s return on equity;
• Recognizing more than just the salary in calculating contributions(for example, bonuses).

It’s important that an I-SERP be designed to fit with the company’s short- and long-term incentive plans, as the requirement to pay out an I-SERP can linger years after an executive has left the company. Companies must carefully draw up individual ISERP contracts, spelling out terms and setting stringent vesting rules to ensure the plans remain aligned with the organization’s business plan.

I-SERPs tie the executive pension offering to corporate results, a positive response to the current debate around pension related governance. They can also become an attractive compensation vehicle for companies that want to develop a SERP structure they can afford.

Christian Laniel is a senior consultant, executive compensation at Watson Wyatt Worldwide in Montréal and Stephane Lebeau is the Human Capital Group Practice Leader, Eastern Market at Watson Wyatt Worldwide in Montréal. christian.laniel@watsonwyatt. com; stephane.lebeau@watsonwyatt.com