Contractor Executive Pay As usual it s a function of the economy

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1 Contractor Executive Pay As usual it s a function of the economy By Ronald C. Phillips and Jeffrey M. Robinson Ninety-nine percent of construction firms are closely held corporations. Most have less than 6 shareholders. Generally, the CEO/President is a majority owner and is responsible for setting business strategy. One element of that responsibility is wage increases, particularly the pay increases of the President s key executives. Hence, when we collect executive wage information, we can, with few exceptions, be assured that while the company President may not have filled out the survey form, he/she did review it. As we shall show later in this article, the President sets the benchmark for executive pay. For that reason, we closely follow current and anticipated executive pay increases simply because they are a bellwether as to how the President views the business environment. If increases are generous, things look promising. If increases are low, meaning anticipated increases fall below current increases, the President views the construction market with caution. Thus, we begin this review of executive pay with a careful review of executive pay increases over the past eleven years. The results are telling. March of 2002 was our last update of executive pay for Building Profits. In that article we remarked at the resilience of executive pay levels in spite of 9/11 terror attacks, a recession, crash of the stock market, and the loss of trust in corporate accounting practices. Well, that resilience eroded as we trudged through 2002 and Right now, we can tell you unequivocally, that construction executives, while hopeful, are, at the same time, cautious about Here is the executive pay trend over the past five years. In 2000 executive increases came in at 5.7%. Very health increases indeed but the prior year was 5.9%. Projections for 2001 averaged 5.1%. Still optimistic and the 2001 actual increases averaged higher than the anticipated. Actual 2001 was 5.4%. However, the projection for 2002 was 4.3%. Optimism is beginning to fade. Actual increases for 2002 averaged 4.7%. That s reasonable given the economy at that time. The projection for 2003 was 4.2% or We re holding our own. The actual average increase for 2003, however, is 4.0%. Note that this is the first time the actual increase is below the projected increase. Consequently, the average projection for 2004 is 3.9%. Clearly, as this downward spiral shows, construction executives are increasingly pessimistic regarding the business climate they face. Underscoring this pessimism is the eleven year history of executive wage increases (Chart 1). For the first time in eleven years executive increases are projected to fall below 4%. All is not doom and gloom, however. There are more hopeful signs both in the economy in general and in construction in particular. Regarding the economy in general, the unemployment rate nationally has dropped from a recent peak of 6.3% to 5.6% in January of According to the Bureau of Economic Analysis, an arm of the Department of Commerce, corporate profits are up in finance, manufacturing and information. The GDP, a measure of the output of goods and services, shows growth in the last two 2002 Article for Building Profits PAS, Inc. Page 1

2 quarters of 2003 that is nothing short of spectacular. In Q3 the GDP grew by 8.2%. In Q4 it grew by 4%. For 2003 the GDP is up over 17%. This increase is a sign that the economy is definitely crawling out of the doldrums. In his most recent testimony before the U.S. Congress, Federal Reserve Chair, Alan Greenspan commented on 2003 as follows. Last year [2003] appears to have marked a transition from an extended period of subpar economic performance to one of more vigorous expansion. After several years of halting recovery from the 2001 recession, prospects are good for sustained expansion. More specific to construction, the turnover of key construction personnel is moving back toward its average of 15%. Employee turnover is measured by dividing the total number of employees by the number of employees leaving the company in the last 12 months regardless of cause. Turnover hit a low of 13% in 2002 indicating that few people were inclined to leave their place of employment. In 2003, turnover rose to 14% with 37% of firms reporting some to high turnover of Superintendents and 31% reporting some to high turnover of Project Managers and 19% for Estimators. Anecdotally, we have received numerous inquiries wanting to know the normal turnover rates for various job titles. This further suggests that firms are experiencing more turnover than expected. Generally, employees are more aggressive about prospecting for new employment when the economy quickens. Consequently, an increase in employee turnover can be an indicator of a healthier construction job market. There are two more important factors to add to this more hopeful picture for First, inflation is not eroding base pay even though pay increases have declined substantially. Chart 2 shows the last eleven years of construction executive increases along side of the annual inflation rate for each year. Though executive increases have declined, they have managed to beat inflation every year. Since 1993 inflation has eroded the dollar by 27%, meaning it takes $127 of buying power to equal $100 in Today, executives have 30% more buying power than they did in In addition, Chart 1 compares the average increases for construction executives along side of their peers within other industries. In each of the eleven years, the average construction executive increase has exceeded those nationally (National increase data courtesy of the WorldatWork). With this background of caution and promise, we begin this review of executive wages by providing our PAS forecast of what we believe will be the actual average executive increase for While Presidents are anticipating a 3.9% increase for 2004, we believe that cautious projection to be partly impacted by the fact that 2003 anticipated increases were higher than the 2003 actual. This is an unusual occurrence and may cause executives to aim lower than necessary in Therefore, we project that with a strengthening economy that actual increases will average 4.2 to 4.3% for Article for Building Profits PAS, Inc. Page 2

3 Construction Executive Pay in In this overview of executive pay, we will examine the six benchmark positions that we have previously reported. For those that follow CFMA wage updates this continuity makes it much easier to compare year to year differences. These six positions are: Board Chair, President or CEO, Executive Vice President, Senior Vice President, the Vice President of Operations and the Chief Financial Officer. Chart 3 illustrates the relationship of base pay to bonus of these six positions. The numbers used are averages based on all types of construction, all types of contractors, all revenue sizes and all geographic areas of the country. The data itself comes from the 20 th annual PAS Executive Compensation Survey for Contractors. The wages shown are effective as of November, Board Chair: The Board Chair is considered the senior officer of the firm that receives salary and benefits. Within the construction industry this position is usually held by one of the major shareholders of the firm. The position is responsible for the company s overall business strategy and objectives. The average base pay for the Board Chair of a construction company in 2003 is $234,000 up from $228,000 in The highest base pay (the 99 th percentile) is $800,000 with total direct compensation (base plus bonus) of $1,100,000. These, total compensation figures are down from $823,000 and $1,467,000 in The average bonus paid to the Board Chair in 2003 is $182,000 down from $199,000 in President/CEO: The position of President or Chief Executive Officer (CEO) is responsible for all day-to-day operations of the business unit. Typically, the President/CEO is an employee-shareholder of the firm. The average base pay for the CEO of a construction company in 2003 is $190,000 up from $184,000 in The average bonus is $139,000 up from $137,000 in The highest average base pay is $633,000 down from $753,000 in 2001 and the highest total direct compensation is $1,610,000 up from $1,443,000 in Executive Vice President: The Executive Vice President within a construction company is usually the number two operating officer and is accountable for a full range of day-today operations or the head of a major segment of the firm. The average base pay for an Executive Vice President of a construction company in 2003 is $158,000 up from $152,000 in The average bonus is $96,000 down from $103,000 in The highest base pay for this position is $398,000 up from $345,000 in 2001 and the highest total direct compensation is $839,000 up from $765,000 in Senior Vice President: The Senior Vice President is a senior level operating officer. He/she is typically responsible for the direction and results of one or more segments of the company. For example, a company may have a mechanical and electrical arm or be divided into new construction and services. In such cases, both segments may have a senior officer in charge. The base pay in 2003 for the position of Senior Vice President is $147,000 up from $137,000 in The average bonus is $72,000 down from $100, Article for Building Profits PAS, Inc. Page 3

4 in The 99 th percentile pay for this position is $472,000 up from $302,000 in 2001 and the highest direct compensation is $591,000 up from $517,000 in Vice President of Operations: The Vice President of Operations position within the construction industry is typically responsible for the day-to-day administration of a major operational work segment. For example, there may be a Vice President of Operations for commercial work and another for industrial construction. The base pay in 2003 for a Vice President of Operations is $115,000 up from $112,000 in The average variable pay is $54,000 up from $45,000 in The highest base pay reported is $214,000 down from $282,000 in 2001 and the highest direct pay is $503,000 up from $382,000 in Chief Financial Officer: The Vice President and Chief Financial Officer position is held by a senior executive with the full span of control and responsibilities for the treasury and accounting functions of the organization. All financial and accounting managers/supervisors report to this officer. In 2003 the average base pay for this position is $121,000 up from $116,000 in The average bonus paid is $46,000 down from $48,000 in The pay for the upper one percent of these officers is $340,000 down from $363,000 in 2001 with the highest direct compensation at $500,000 down from $577,000 in The Variable Pay Trap One obvious conclusion from this litany of wages and bonuses is that variable pay (bonus as an example) has been significantly reduced in 2003 in comparison with This significant downturn in variable pay is especially troublesome for those firms that have chosen to emphasize variable pay over base pay. It has been a trend for the past few years for companies to move toward incentive pay (variable pay) and away from base pay as their primary means of compensation. There are two reasons for this move. One reason is to motivate employees to achieve specific business objectives. To do this a company incentivises its objectives. The second reason is to better manage fixed costs. Since variable pay is variable depending on revenues, it is technically not a fixed cost. Unfortunately, there are firms that have become so enamored with variable pay such that their programs account for 40 to 50 percent of employee compensation. Here is the rub. When the economy slows, as it has been, variable pay is cut and cut substantially. What these firms are finding is that what was sold as variable pay is not so variable. In fact, it is a hidden fixed cost. Direct compensation cannot fall below market rates without serious consequences. Hence, whatever portion of a company s compensation is equivalent to the market is not variable pay. But the problem doesn t end there. By over emphasizing variable pay, companies do not maintain base pay at market rates. Hence, when the economy does improve, these same firms are not able to hire experienced personnel because their base wage is subpar for the industry Article for Building Profits PAS, Inc. Page 4

5 Variable pay programs can be effective in improving performance and in attracting talent. However, they must be well managed. Variable pay programs prove effective as a compensation strategy as long as base pay remains competitive with the market. Variable pay is additional compensation. To see it otherwise is to cook the books so to speak. CFO Compensation Update Because many of the members of CFMA are the Chief Financial Officers of their companies, it is appropriate for this readership to single out the CFO title for further explication. People like to know what others like them are being paid and where their pay fits within the industry. Hence, we include this CFO compensation update. To breakout like positions, however, takes some understanding of what demographics are relevant in making pay comparisons. One cannot assume that all CFO s are alike in their duties and responsibilities. To solve this problem we regularly run a regression analysis on position wages and various demographics. Regression analysis is a statistical procedure that determines what factors, in this case wages, correlate with certain demographics. The results are inevitably the same. Revenue size is the strongest correlate for executive pay. This correlation holds true for all of the eighteen executive positions for which we collect pay information. Thus, revenue size is the best way to compare CFO pay for this compensation update. Our revenue breakouts include an under 5 million category. However, this year we have made the decision to eliminate this breakout. The reason for this is that a construction company doing under 5 million in revenue is usually composed of 5 to 10 FTEs. That size firm simply will not have a Chief Financial Officer in the sense that we use the term. Usually in these smaller firms the Owner/Boss oversees the company s financial practices with the help of a bookkeeper and a CPA consultant. We do get firms of this size to give us pay information on the CFO position, but the information is so inconsistent as to be unusable. Hence, the reason we have eliminated this breakout from this year s update. The CFO charts 4, 5, and 6 give the comparative picture of base pay, bonus and the upper 1% respectively for each of the revenue breakouts. In addition to these charts which are self-explanatory, we describe the normal pay ranges as defined by the 25 th and 75 th percentiles. These ranges should provide the CFO readership with a better means of comparing how individual compensation fits within the industry. CFOs In Firms Under 25 Million In Revenue Size Base pay for these CFOs range from $70,000 at the low range to $100,000 at the high range. The average pay is $86,000. Bonuses range from a low of $10,000 to a high of $30,000 with the average bonus being $20,000. The upper one percent in level of pay receives an average of $173,000 in base pay and total direct pay of $207, Article for Building Profits PAS, Inc. Page 5

6 CFOs In Firms Between 25 to 100 Million In Revenue Size Base pay for these CFOs range from $98,000 at the low range to $135,000 at the high range. The average pay is $117,000. Bonuses range from a low of $17,000 to a high of $50,000 with the average bonus being $42,000. The upper one percent in level of pay receives an average of $212,000 in base pay and total direct pay of $358,000. CFOs In Firms Between 100 to 250 Million In Revenue Size Base pay for these CFOs range from $100,000 at the low range to $140,000 at the high range. The average pay is $128,000. Bonuses range from a low of $19,000 to a high of $80,000 with the average bonus being $56,000. The upper one percent in level of pay receives an average of $210,000 in base pay and total direct pay of $333,000. CFOs In Firms Between 250 to 500 Million In Revenue Size Base pay for these CFOs range from $107,000 at the low range to $177,000 at the high range. The average pay is $158,000. Bonuses range from a low of $38,000 to a high of $81,000 with the average bonus being $56,000. The upper one percent in level of pay receives an average of $251,000 in base pay and total direct pay of $270,000. CFOs In Firms Over 500 Million In Revenue Size Base pay for these CFOs range from $141,000 at the low range to $313,000 at the high range. The average pay is $211,000. Bonuses range from a low of $40,000 to a high of $185,000 with the average bonus being $104,000. The upper one percent in level of pay receives an average of $325,000 in base pay and total direct pay of $500,000. The Hierarchy of Executive Pay It s a Rule As we stated at the beginning of this article, the President/CEO is the person who sets the pay of his/her executive team. This means that the CEO s compensation is the benchmark for what others are paid. That, on the face of it, makes a certain rational sense. How goes the CEO, so to speak, goes the company. But it goes much further than that. The CEO s compensation determines exactly the order and the amount of compensation for the entire executive team. For example, if, say, the CEO is paid $100,000 in base wage (this rule covers base wage only), then we automatically know, in most cases, the compensation of the rest of the team. The Chair s compensation is $125,000, the Executive V.P. receives $84,000, the Senior V.P. gets $74,000, the CFO is paid $64,000 and so on down the hierarchy. How do we know that? We simply take all the companies in our database and calculate the wages of each position as a proportion of the CEO s compensation. Regardless of the 2002 Article for Building Profits PAS, Inc. Page 6

7 year or the number of companies, the outcome is the same. Table 1 shows the calculations. Table 1 Compensation as a Percentage of the CEO Brd Chair Ex VP Sr VP VP Ops CFO % 87% 77% 61% 65% % 82% 73% 61% 61% % 80% 70% 61% 63% % 87% 73% 63% 65% % 83% 75% 61% 63% % 86% 75% 63% 65% % 83% 77% 60% 64% Average 125% 84% 74% 61% 64% The Rule of Executive Compensation Why is it so that almost every construction firm (and we suggest this crosses industries although the percentages may not be the same from industry to industry) pays its executives in mathematic proportion to what it pays its CEO? We have no idea. You might as well ask why we can calculate the length of the hypotenuse of a right triangle using the Pythagorean theorem. But the fact that it is inexplicable does not make it less true. It is a rule of executive compensation and its importance should not be underestimated. This rule makes assigning executive pay a no-brainer. Set the CEO s pay and follow the rule for everyone else. If the CEO is paid in accord with the market, all is well. On the other hand, if the CEO is paid below the market, that means that all the executives are paid less than the market and you can bet there will be trouble in River City. This humble CEO scenario is more common than one might think and illustrates what can happen if the rule is not followed. Suppose, for example, a CEO concludes he/she does not need what is concluded to be excessive compensation and reduces it to something below market. This act of humility will cause value problems with the executive team whether or not anyone else s compensation is affected. The whole executive team has been demeaned. Suppose on the other hand, the CEO s pay is excessive. This too causes serious discontent in the executive team. How come the wealth is not shared? In other words, whether the CEO is underpaid or overpaid it breaks the rule and all of the executive team is impacted. What this rule helps us to remember is that compensation is not a matter of need or ego. It is a matter of perceived value in the market. It s a rule and a rigid one at that Article for Building Profits PAS, Inc. Page 7

8 Outlook on Compensation In 2004 In summary, construction presidents are taking a cautious view of executive increases in 2004 and are forecasting a 3.9% increase, the lowest increase in over eleven years. On the other hand, corporate profits are up, and the Fed Chair thinks things are coming around. On that positive note, PAS is projecting 2004 executive increases to be in a range of 4.2 to 4.3 percent. The economic slow down has significantly reduced variable pay and those firms that have established aggressive variable pay programs may be in for some tough sledding as the economy rebounds. Finally, as construction executives enter 2004, they do so ahead of their counterparts in other industries. Not only is real income up but once again construction executive wage increases have exceeded the national average for eleven years running. No cause of tears in this report bring on two thousand four. About The Authors Ronald C. Phillips & Jeffrey M. Robinson are co-owners of PAS, Inc. PAS is a survey research company that specializes in wage and benefit information for the construction and engineering industry. Descriptions of PAS products and services can be found on the World Wide Web at or call for a free copy of the PAS product listing Article for Building Profits PAS, Inc. Page 8

9 **********************************Relevant Charts************************* Chart 2 - Executive Wage Increases & Inflation 6% 5% 4% 3% 2% 4.9% 2.7% 5.2% 2.7% 5.4% 2.5% 5.5% 3.3% 5.0% 1.7% 5.6% 1.6% 5.9% 2.7% 5.7% 3.4% 5.4% 1.6% 4.7% 2.4% 4.0% 1.9% 1% 0% Construction Executives Consumer Price Index Chart 1 - Construction & National Executive Increases 6.83% 5.88% 4.92% 3.96% 3.00% 5.9% 5.6% 5.4% 5.5% 5.7% 5.2% 5.4% 5.0% 4.9% 4.7% 4.0% 4.8% 4.7% 4.5% 4.6% 4.5% 4.4% 4.3% 4.1% 4.0% 4.1% 3.6% Const Exe All Exec 2002 Article for Building Profits PAS, Inc. Page 9

10 Chart 3 - Executive Wages (in thousands) $200 $150 $190 $139 $234 $182 $158 $147 $115 $121 $96 $100 $72 $54 $46 $50 $0 CEO Chair Exec VP Sr. VP VP Ops CFO Base Salary Bonus $200,000 Chart 4 - CFO Base Salary $158,000 $211,000 $150,000 $117,000 $128,000 $100,000 $86,000 $50,000 $0 <25 Million Million Million Million >500 Million 2002 Article for Building Profits PAS, Inc. Page 10

11 Chart 5 - CFO Average Bonus $100,000 $104,000 $75,000 $56,000 $56,000 $50,000 $25,000 $20,000 $42,000 $ Million Million <25 Million >500 Million Million Chart 6 - Three Highest Paid CFO's $600,000 $500,000 $500,000 $400,000 $317,000 $333,000 $270,000 $300,000 $207,000 $200,000 $100,000 $0 <25 Million >500 Million Million Million Million 2002 Article for Building Profits PAS, Inc. Page 11