Initial public offering investors need assurances that the executives who built the company they're buying will be staying aboard. Should these individuals jump ship, investors fear, the success of the enterprise would be in jeopardy.

The most critical factor in retaining and motivating senior executives is their potential to reap performance rewards post-IPO. Because public company compensation dynamics fundamentally differ from those of private companies, the pay programs of IPO companies usually require changes to boost their retentive and motivational value and allay market concerns that key executives may leave.

Accordingly, deal consultants and attorneys preparing companies for launch should determine what, if any, compensation changes to recommend to clients. Tweaking pay programs usually falls short of the mark. Typically, they need restructuring -- an undertaking requiring extensive planning.

The first step is to take an inventory of existing pay programs. Then assess the programs against those of competitors, determining not only how much but how they pay executives in the same positions. The best way to do this is to establish a peer group of public companies of comparable size and complexity that have similar needs for executive talent. Analysis of peer group salary levels and incentive pay opportunities will suggest changes needed to fend off potential suitors.

An important item in peer group comparisons is long-term incentive, or LTI, plans -- the most critical pay element for creating shareholder value. Oftentimes, pre-IPO equity incentives will liquidate shortly after an IPO and need to be replaced with appropriate public company incentives to keep executives from leaving at this critical juncture, and for market perception.

Public company LTIs typically involve stock options, restricted shares and performance shares (earned commensurate with performance over a set period). Their design is the subject of close scrutiny by institutional investors.

Well-designed LTIs align executives' long-term financial interests with those of shareholders. When these plans are underweighted (or nonexistent), executives seeking short-term rewards may be more inclined to take undue risks whose negative impacts might not manifest for years. Such unintended consequences have become painfully evident recently at
some companies.

Performance-based LTI plans typically have performance periods of at least three years, overlapping indefinitely. By the time executives receive payouts from one period, they're well into the next. Thus, they're continuously motivated to strive for the next carrot, ever mindful of how their actions may affect their long-term prosperity.

Taking a privately held company public often requires addressing certain compensation program red flags that attract investor scrutiny. Examples include guaranteed payments, lucrative severance programs, excessive perquisites/benefits and tax gross-ups.

Going public also typically requires changes in board composition and compensation. Some directors may need to be replaced to comply with Securities and Exchange Commission independence rules (requiring nonemployee directors) and to meet needs for specific qualifications. Director compensation may need to be adjusted to account for public company responsibilities and risk. It usually consists of a fixed annual retainer and equity with required holding periods. Incentive plans aren't necessarily appropriate for directors because they may conflict with their oversight role.

Both director and executive pay programs are under increasing regulatory and governance pressure to clearly disclose the rationales for compensation elements using plain English. Further, the recently passed Dodd-Frank Wall Street Reform and Consumer Protection Act requires shareholder votes on public company pay plans (known as "say on pay"), effective next year. Though these votes are nonbinding, they will nonetheless ratchet up pressure on boards from proxy advisory services. Hence, it's imperative to make the case in proxy statements for how plans will create shareholder value. Failure to do so could result in shareholders' rejecting plans or worse, voting newly installed directors off the board right out of the gate.

IPO companies can avoid these troublesome scenarios by building enough time into prelaunch work schedules to meet the increasingly stringent demands of the public market.

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Ryan Harvey and Bryan Smith, partners and senior consultants of Meridian Compensation Partners LLC, specialize in compensation issues in transactions such as IPOs and M&A deals.