by Alan Goldfarb

As a growing number of American companies dive into the global marketplace, the need for seasoned, skilled executives is stronger than ever. For top executives, that’s great news: Outside their window is a huge market for their talent.

For company owners, however, today’s competitiveness is only making it harder and harder to retain valued employees. It can be demoralizing for company chieftains who know that if they are to succeed in coming years, they must retain their best workers. Losing them doesn’t just jeopardize the ability to compete, it’s also expensive.

Historically American companies have used various methods to retain executives, including extra bonuses, promotions and pay raises, or perks such as company cars, travel privileges, extended vacation time, etc. Unfortunately, these one-time benefits rarely make much difference, studies show. They may keep someone around an extra month, or however long it takes to exhaust the benefits, but that’s about as far as they go.

What has made a difference are “golden handcuff’’ agreements, and an increasing number of companies are adopting some version of them. Although the name of these agreements may be a bit off-putting, at least it’s honest. Golden handcuff agreements indeed tie an executive to the company, but the reward can be substantial and may even include a share of ownership.

For owners, a golden handcuff agreement can be an expensive way to lock in top executives. Part of the company’s assets will have to be given up either through stock options, deferred payments, phantom stock, or a similar plan. However, if it keeps the top employee on staff it’s a move that actually should enhance revenue, and therefore should be seen as an investment and not an expense.

Golden handcuff agreements can be either very simple or highly complex. One simple agreement might be a promise by the company to repay an executive’s college debt, as long as the executive stays at the company a certain number of years. Or a company may agree to make payments on an executive’s lease car, but again only if he or she remains with the firm.

More complicated are deferred compensation or salary continuation programs, such as Secular Trusts, Rabbi Trusts or a conventional deferred compensation/disability agreement. These plans essentially grant the employee continued compensation after retirement or disability, but the employee cannot leave the company before the agreed time.

What experienced executives want the most, studies show, is some form of equity participation. There are numerous ways this can be provided, including by means of stock grants. For example, a company may simply give stock shares to a top performer. That makes him feel like an owner, and may dispel any thoughts of jumping ship. A major drawback, however, is that ownership begins whenever the shares are awarded. If the employee is so inclined, she can sell her shares as soon as she gets them and then bolt the company.

Non-qualified stock options are a better option. This gives an employee the option to buy shares at the “grant price,’’ which typically is the current share value. As the company gains in value, so does the value of the shares. However, options usually have a vesting period before shares can be purchased, which means the employee has to stay with the firm for several years. The good news for the employee, however, is there is no tax liability until the option is exercised. But it’s important to remember that options do not bring voting rights.

Perhaps the best way to bestow ownership is through “phantom stock.’’ Phantom shares are particularly beneficial for companies that don’t want to dilute either ownership or control, or have a Subchapter S and can’t exceed the maximum of 35 shareholders.
Phantom stock isn’t actually stock — it’s a deferred monetary award that is indexed to equity value or stock. The most common phantom stock plans establish compensation units that derive their base value from the value of a company’s common stock. When awarded, these units carry tax advantages similar to those of other deferred compensation.

Phantom stock plans offer numerous advantages to employees because they receive cash, not stock with an uncertain future value. In addition, they aren’t forced to invest in the company. Among the advantages to owners is that a phantom stock plan, as opposed to an Employee Stock Option Plan (ESOP), allows owners to hand-pick those who will be given ownership. An owner can do this by offering select employees the opportunity to participate in the growth of the company. For example, a key employee would receive a certain number of phantom units. Each unit would have the same value as a share of the company’s common stock on the date the unit is issued. The employee gets nothing until retirement, death or disability. Depending on how the plan is established, when the employee ends his active employment he may receive a sum equaling the difference between the original unit price and what that unit is worth at the end of his tenure. A variation would be that the employee receives full value.

Phantom stock is taxed like unfunded deferred compensation. The employee reports no taxable income, and the employer takes no deduction when the phantom stock is assigned to the recipient’s account. Once the employee retires, or fulfills the established tenure, he or she is paid in installments over a number of years and pays taxes on the income. The employer then can claim a deduction each year a payment is made.

Phantom stock, non-qualified stock options, stock grants, deferred compensation — these and other forms of golden handcuffs provide a way for companies to keep their top talent. However, company owners need to discuss their options with a legal adviser and investment counselor before putting together a formal plan. Not all golden handcuff agreements work in all situations, and all of them carry certain risks.

With the proper guidance, however, golden handcuff agreements can be a very effective tool in retaining top executives. They offer a way to keep experienced, skilled executives on board at a time when turnover is becoming inordinately expensive and disruptive.

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Alan Goldfarb is director of Financial Strategies for Weaver and Tidwell Financial Advisors Ltd. (www.wtadvisors.com) in Dallas, Texas. A Certified Financial Planning practitioner, Goldfarb has been named Top Financial Advisor by Worth magazine six times. He holds an MBA in economics and management from the University of North Texas and a bachelor’s degree in engineering and management from Fairleigh Dickinson University. He can be reached 972-960-1100.