Executive Deferred Compensation balancing responsibilities. (Executive Compensation).

Executives have enjoyed the benefits of Executive Deferred Compensation (EDC) plans for years. Designed for an organization's top management and/or highly compensated employees, these nonqualified plans (also known as Top Hat, Voluntary Deferral or 401(k) Mirror/Restoration plans) have increased in popularity as companies continue seeking ways to attract and retain key talent, while securing current assets to pay future benefits.

EDC plans allow top management to defer income tax on current compensation, including bonuses. Unlike qualified plans, such as 401(k)s, plan participants can contribute as much as their employer will allow, up to 100 percent of compensation. In some cases, the company makes contributions to the plan as well, sometimes with guaranteed rates of return.

Since many corporate decision-makers are also EDC plan participants, a dilemma emerges: How do EDC plan sponsors, who are also plan participants, balance their personal interests with those of the business and other stakeholders when designing and managing nonqualified plans?

Changing Landscape

During the market boom of the late 1990s, many companies began changing their EDC plans offerings from guaranteed rates of return to market-based returns. Much of this was attributed to management wanting its executives to enjoy the same great market-based returns in their nonqualified plans as they did in their qualified plans. Executives were able to map their 401(k) investments to their EDC plans -- which made plan communications more manageable -- but companies also enjoyed market performance, as their EDC assets began to keep pace with their EDC liabilities.

Trends indicate that today's executives may be more hesitant to participate in EDC plans with their own dollars. While tax-deferred growth on income is still attractive, participants with large account balances have become increasingly concerned they may not see the compensation they elected to defer.

On average, ADP Retirement Services reports a decline in 2003 elections for voluntary deferred compensation. Along with concerns about companies' financial stability, this drop can be traced to the economic climate, concerns over job security and an overall belief that now, it's best to be conservative with current cash compensation.

Companies are reacting to the changing environment as well. One trend emerging at companies with large deferred compensation liabilities is the consideration to accelerate payments to participants. There are several reasons for this. One is a company's desire to fulfill promises it has made to executives by paying them compensation that was deferred in good faith.

A second reason is that companies are making efforts to demonstrate responsibility to shareholders by paying down large plan balances. Payment of EDC balances also results in recognition of a previously delayed business tax deduction for the company (with 401(k) plans, the business tax deduction is allowed when contributions are made).

Decisions to accelerate payments are typically policy-driven. A change of this type naturally elicits mixed reactions. Some executives may be pleased to receive the cash, while others may resent being forced to take the distribution and pay the associated federal and state income taxes.

Recent corporate scandals have cast a harsh light on executive compensation as it relates to corporate responsibility. There is a general lack of understanding of how executive compensation programs work, due to the fact that they're designed and targeted for such small groups. It is important to note that without such programs, upper management is severely challenged to save on the same pre-tax basis as rank-and-file employees. For most companies, EDC plans not only help with recruitment and retention, but help level the playing field for management-level employees.

Keeping the Balance

While executives are faced with business decisions that affect many lives, one decision that doesn't change is how the majority of plan sponsors -- often are also plan participants -- balance personal and professional interests. The overwhelming response from several ADP Fortune 500 EDC clients was, "responsibility is first and always to the company and the success of its programs." When developing EDC plan strategies, "there is never a doubt that you put consideration for the greater good before your individual needs." However, personal perspective can be beneficial. Decision-makers, who also are eligible to participate in a plan, have a unique perspective when thinking through how that plan will achieve intended goals for all parties.

For example, during the 1990s mergers boom, many plan sponsors built certain "change in control" provisions into their nonqualified plans. These provisions served to protect deferred compensation through immediate vesting of participant accounts or automatic lump-sum payment of benefits in the event of a takeover. Acting as both sponsor and participant, these executives created policies incorporating the perspectives of the company, shareholders, employees-at-large and plan participants.

Companies do not have to -- and arguably should not -- act alone when developing and implementing EDC plans. Partnering with consultants, financial advisors and plan administrators provides key perspectives on how their compensation packages are aligned with corporate goals and financial considerations.

Checks and Balances: From Inside

The Turner Corp., a leading U.S. commercial builder, provides an excellent example of maintaining balance between corporate and participant needs. Turner has had an EDC plan in place since 1979. Its goal: to provide its executives with a compensation program that is competitive, easy to manage and carries zero balance sheet impact. Today, the company holds assets to balance its EDC plan liability in the form of corporate-owned life insurance.

Turner's Director of Benefits, Pat Aulson, says the company's checks and balances ensure the needs of the executives, the company and shareholders are met. "Participant involvement is our number one checkpoint. Our executives are able to look at their balance every day via a secure Web site. If something doesn't look right, they'll let us know immediately."

Turner is leveraging technology in all of its employee benefits offerings to keep the process simple, accurate and easily accessible. "Most of our executives are out in the field -- one of the reasons we developed a Web site, for ease of access and effective management of these plans," says Aulson.

Turner also has a committee that oversees the EDC plan and conducts regular reviews, making sure that participants maximize their opportunities, while the company's assets are closely matching its liabilities. All committee members vote on decisions regarding the overall plan. However, most of the committee members are also plan participants. In the event a decision is directly connected to his/her individual compensation package, the participant committee member does not vote.

It's important to note that EDC plan assets don't have to match the liabilities, since all assets are general assets of the corporation. Another Turner priority is having enough set aside to cover the deferred compensation accounts.

Turner elected to outsource its EDC plan administration to provide ease of access and accountability for accurate recordkeeping, and it works with an independent broker for coordination with the insurance company in addition to a plan administrator. Outsourcing also provides EDC plan sponsors and participants with daily plan valuations, live customer service, interactive Web capabilities, online enrollment and coordination with brokers or other financial advisors.

Most companies' compensation and benefit programs, including EDC plans, are designed with concern for the individual and integrity of the company in mind. Those that have taken advantage of and abused corporate responsibility are in the minority, although the news may indicate the opposite. Corporate America will responsibly continue to evolve compensation strategies and plan designs, as that makes sense for companies and executives. Implementing a clear system of oversight and checks and balances is a fundamental premise.

Rosemary Murphy is Director, Executive Deferred Compensation, for ADP Retirement Services, and can be reached at Ros [e-mail]. Automatic Data Processing Inc. (ADP) is one of the largest independent computing services firms in the world (www.adp.com).