Executive Compensation Considerations for Government Contractors

Executive compensation presentation is a critical consideration for government contractors who are subject to Federal Acquisition Regulation (FAR) regulation, which contains the cost principles that govern the allowability of executive pay on government contracts (FAR 31). This post will provide a clear understanding of who is considered an executive under FAR 31, outline the statutory compensation limits, and demonstrate how contractors can strategically use compensation surveys to justify higher allowable compensation.

Who Is Considered an Executive?

FAR 31.205-6(p) focuses on the compensation cap of certain contractor employees. The determination of who qualifies as an “executive” is critical, as the rules impose statutory limits on the allowable compensation cost for employees who are considered to be in a management position.

In practice, “executive” refers to those individuals who:

• Occupy the highest management positions at the company.
• Titles include Chairman, Chief Executive Officer (CEO), Chief Financial Officer (CFO), Chief Operating Officer (COO), Executive Vice President (EVP), Vice President (VP), Engineering Executive, Human Resources Director, and Director of Business Development.

It is important to note that these designations are not always tied to official titles but to actual job responsibilities and reporting lines. The determination is made annually, based on the compensation paid in the contractor’s fiscal year.

For multi-segment contractors, each segment with separate indirect cost allocation may have its own set of executives. It’s also important to note that single-segment entities may have multiple employees fitting the roles outlined above. In cases such as these all employees fitting these roles should be included in the evaluation of executive compensation.

The American Association of State Highway and Transportation Officials (AASHTO) publishes the definitions for these executive positions and their respective maximum allowable salary.

Statutory Compensation Limits

To control costs to taxpayers, the federal government imposes an annual statutory maximum on the amount of compensation that may be charged to government contracts for these top executives. The Office of Federal Procurement Policy (OFPP) issues these caps, adjusting them annually based on the Employment Cost Index for all workers as published by the Bureau of Labor Statistics.

• 2024 Statutory Limit: For compensation costs incurred in contractor fiscal year 2024, the cap is $646,000.
• Lesser thresholds are in place for those not considered to be CEO/President, EVP, or COO.

These caps apply not only to direct salary but also to all forms of compensation: wages, salaries, bonuses, deferred compensation, and employer contributions to defined contribution pension plans. It is also important to note that these limits apply to all contracts awarded on or after June 24, 2014, and to all employees whose compensation is charged to such contracts.

How Contractors Can Use Compensation Surveys to Increase Allowable Limits

While the statutory caps are firm for contracts subject to the government-wide limit, certain contracts, especially those awarded before June 24, 2014, or otherwise grandfathered under superseded rules, may allow for higher limits based on industry benchmarks. Furthermore, for executives not governed by a lesser statutory cap (those not considered CEO/President or EVP/COO), contractors may justify higher compensation as reasonable by referencing compensation surveys.

Understanding the Reasonableness Standard

FAR 31.205-6(b) requires that compensation must be reasonable for the work performed. “Reasonableness” is determined by considering whether the compensation is comparable to that paid for similar services in comparable businesses or industries.

To establish reasonableness, contractors often rely on compensation surveys conducted by human resources consulting firms. These surveys compare salary and total compensation based on:

• Job function and level of responsibility
• Industry sector (aerospace, defense, IT, etc.)
• Company size (by revenue or employee count)
• Geographic location

Steps for Using Compensation Surveys Effectively

Contractors seeking to justify compensation above the government cap (where allowable) should follow these best practices:

1. Select Reputable Surveys: Use reputable, widely accepted industry compensation surveys.
2. Match Position Descriptions: Align the company’s job positions as closely as possible to the survey’s benchmark categories, considering duties, responsibilities, and reporting relationships.
3. Adjust for Company Size and Region: Compensation often scales with company size and varies by region. Ensure that survey data for companies similar in size and geography is used.
4. Document Your Analysis: Maintain comprehensive records of how the survey data was selected and applied. The rationale should be clear, logical, and defensible in the event of a government audit.
5. Calculate Median or 50th Percentile Compensation: The reasonableness standard is usually anchored to the median (50th percentile) of comparable positions, not the highest paid. Be prepared to justify any deviation above the median.
6. Address All Forms of Compensation: Consider all types of pay, not just base salary. This includes bonuses, stock awards, retirement contributions, and other fringe benefits.

Responding to Audit and Oversight

If a government auditor questions the reasonableness of executive compensation, one’s response should include:

• Copies of the compensation survey(s) and the relevant data extracts
• A mapping of the company’s executive positions to the survey benchmarks
• A detailed narrative explaining adjustments for size, industry, and region
• Documentation of company policies and compensation committee deliberations

Transparency, consistency, and documentation are the strongest defenses in supporting an organization’s compensation practices.

Conclusion

Compliance with FAR 31’s executive compensation rules is critical for contractors seeking to maximize allowable cost recovery and minimize the risk of audit findings or financial penalties. By identifying covered executives correctly, adhering to the statutory limits, and leveraging high-quality compensation surveys, contractors can not only ensure compliance but also make a compelling case for compensation that matches industry standards. The process can be complex, but with diligent documentation and a proactive approach, companies can navigate these waters confidently and effectively.

To learn more about FAR 31 allowability, FAR audits, and FAR compliance, you can find additional articles from our AEC team here. For more information about McKonly & Asbury’s Architecture, Engineering, and Construction (AEC) experience, visit the AEC Industry Page and don’t hesitate to contact a member of the AEC team.

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