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Executive pay

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By Patricia K. Zingheim, Jay R. Schuster and David A. Thomsen

The boards and CEOs of tax-exempt charities and social-welfare organizations are being tested as they evaluate their executive compensation programs in 2005.

Boards are challenged to reward executive performance. Now, the Internal Revenue Service is cracking down on perceived abuses of excessive compensation.

In 2004, the Exempt Organizations Division of the IRS created new offices that focus, in part, on compensation abuses in charitable organizations.

Boards have a fiduciary duty to comprehend and design compensation arrangements that are reasonable. Rewards must reflect the organization’s performance compared to other similar organizations.

An active IRS increases the likelihood of problems being uncovered. The consequences for board members are significant.

Effective governance of the executive compensation program through pay for performance is the answer.

Executive compensation must vary with the performance of the organization based on concrete and pre-established metrics.

Some steps to follow are:

* Select measures and goals that match executive responsibilities for the organization’s future.

* Formally evaluate executive performance in relation to preset individual and organizational goals.

* Compensate executives based on goal achievement.

* Closely monitor and regularly review executive compensation arrangements in order to avoid intermediate sanctions.

* Ensure compensation reasonableness by using data sources that the IRS will accept as appropriate and include unbiased measures of competitive compensation.

What is reasonable compensation in terms of competitive practice?

Boards should include, among other critical factors, the following steps in their evaluation of reasonable compensation:

* Obtain and rely upon robust, comprehensive and reliable compensation comparability data relating to the job and organization in question in terms of geographic location, industry, company size and specific job functions.

* Consistently apply this comparability data by rewarding performance when goals are met, while carefully avoiding material modification to the underlying compensation arrangement.

* When appropriate, utilize the services of an independent, competent compensation professional who is free of any potential conflict with the executives and board members.

Patricia K. Zingheim is president and Jay R. Schuster is CEO of Baker, Thomsen Associates in Newport Beach, Calif. David A. Thomsen is senior advisor to ERI Management for the ERI Economic Research Institute in Redmond, Wash.

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