Employee Stock Ownership Plans occupy a unique place in the ownership and compensation landscape. An ESOP is a qualified retirement plan designed to invest primarily in employer securities, which means employees can build retirement wealth through ownership in the company where they work.
A reasonable compensation analysis answers a practical question: is the pay provided to executives, key employees, or highly compensated employees reasonable in amount for the services actually rendered? In an ESOP-owned company, that question matters because compensation can affect earnings, cash flow, valuation, annual share value, and participant retirement outcomes. Pay must therefore be evaluated not only as a recruiting and retention tool, but also through a fiduciary and participant-value lens.
Current ESOP Compensation Practice: What the Available Data Shows
The practice of conducting formal reasonable compensation analyses is often embedded within board, trustee, compensation committee, valuation, transaction, or annual governance reviews. While it remains difficult to identify a definitive percentage of ESOP companies that conduct one as a standalone process, the trend toward this practice is becoming clearer.
Recent ESOP compensation data demonstrates that benchmarking and independent compensation review are increasingly mainstream. The National Center for Employee Ownership’s 2025 ESOP Executive and Board Compensation Survey received 559 privately held ESOP company participants, compared with 383 in the 2023 survey. This uptick points to a growing concern with giving ESOPs the data they need to make informed choices. The NCEO notes that boards in most ESOP companies are taking a more active role and seeking independent voices in compensation decisions. Those statistics do not prove that all ESOPs complete reasonable compensation opinions, but they strongly support the conclusion that ESOP pay benchmarking and independent governance review are now standard practice for many ESOP companies.
The latest compensation statistics also show why a total-rewards analysis is important. NCEO’s 2025 survey reports that approximately 30% to 40% of surveyed ESOP companies offer stock-based compensation to executives and about seven in ten contribute to a qualified retirement plan in addition to the ESOP. A related NCEO summary indicates that 80% of surveyed ESOP companies provide cash incentive pay and 32% provide equity pay. These findings show that ESOP executive compensation is often more complex than salary alone and should be evaluated across base pay, incentives, retirement contributions, benefits, and equity-like or synthetic equity arrangements.
What the Analysis Should Cover
Reasonable compensation is facts-and-circumstances based. It is not determined by title alone, or by whether pay falls above or below a single market percentile. The analysis should evaluate what an unrelated company would reasonably pay for comparable services under comparable circumstances, considering company size, industry, geography, role scope, performance, experience, retention risk, and the full value of the compensation package.
For ESOP-owned companies, the first step is defining the role being reviewed. Titles vary significantly across private and closely held companies. A CEO, president, COO, CFO, or various VP positions may have broader or narrower responsibilities than the title suggests. A well-supported analysis focuses on the substance of the role: decision-making authority, operational accountability, financial impact, customer exposure, employee oversight, strategic importance, and contribution to enterprise value.
The second step is evaluating company context. Compensation that is reasonable for a large, diversified, highly profitable company may not fit a smaller, lower-margin business in the same industry. Above-median pay may be appropriate where the company has strong financial performance, specialized talent needs, meaningful retention risk, or executives who materially influence results. In an ESOP setting, market competitiveness must be balanced against affordability and participant impact.
A comprehensive review should evaluate total compensation, not merely base salary. Conservative base salary can coexist with elevated total cash compensation if annual incentives, profit sharing, commissions, retirement contributions, or benefits are significant. That distinction matters. High fixed pay may create different concerns than high variable pay tied to defined performance results. Where incentive payouts drive upper-market positioning, the company should be able to show that payouts were earned, formulaic, performance-linked, consistently applied, affordable, and approved through an appropriate governance process.
Why Governance Documentation Matters
Reasonable compensation analysis is also a governance tool. ESOP fiduciaries are responsible for protecting the interests of plan participants and beneficiaries. The U.S. Department of Labor has emphasized that the Employee Retirement Income Security Act (ERISA) imposes duties of prudence and loyalty on fiduciaries and restricts certain transactions involving conflicts of interest or parties in interest. While much ESOP regulatory attention focuses on stock valuation and adequate consideration, compensation practices can raise similar governance concerns, namely whether the ESOP is being operated in a manner that protects participant value and follows a prudent, well-documented process.
The analysis can also distinguish compensation for services from returns on ownership. This is especially important in closely held and ESOP-owned companies where executives, sellers, founders, family members, or legacy shareholders may have overlapping roles as employees, owners, directors, or transaction participants. Compensation should reflect the value of services performed, not serve as a disguised distribution of ownership value or a mechanism for transferring value away from plan participants.
A strong analysis creates a defensible record. Boards, compensation committees, trustees, and management teams often make pay decisions under time pressure, during retention issues, leadership transitions, transaction planning, or incentive payouts after strong performance years. A formal review documents the data reviewed, assumptions used, methodology applied, market references, factors considered, and rationale behind the final decision.
Useful documentation includes approved performance goals, actual results, bonus calculations, incentive plan design, market data, affordability metrics, board or committee minutes, and an explanation of how participant impact was considered. Not every ESOP company needs an overly complex report every year, but companies should have enough objective support to show that pay decisions were prudent, independent, market-informed, and tied to legitimate business considerations.
Ultimately, reasonable compensation analysis protects multiple stakeholders. It helps management understand whether pay is competitive and aligned with performance. Boards and compensation committees gain better-supported decisions, and trustees get a clear ESOP fiduciary lens for evaluating pay. Most importantly, the analysis protects employee-owners by ensuring that compensation practices do not erode the retirement value the ESOP was created to provide. For ESOP companies, reasonable compensation is not merely a technical tax or compliance concept. It is a practical governance discipline that helps align employees, leadership, and long-term company success.
Partner With CBIZ on Your Compensation
Not sure your pay decisions would hold up? A CBIZ advisor can run the reasonable compensation review that gives you the answers, the support, and the peace of mind. Connect with CBIZ today.
Frequently Asked Questions
There is no fixed rule, but most ESOP companies revisit compensation at least once a year, usually alongside the annual valuation or board review. A yearly cadence keeps market data current and gives trustees a fresh record to rely on. Companies also run a review when something changes, such as a leadership transition, a new incentive plan, a major performance year, or a transaction. The goal is simple: never let pay decisions outrun the data behind them.
In most ESOP companies, the board of directors sets executive pay, often through a compensation committee made up of independent members. The ESOP trustee has a fiduciary duty to plan participants and may review proposed pay to confirm it is fair to employee-owners. In practice, these groups work together: the board and committee handle the market and performance side, and the trustee weighs participant impact. When a trustee is also a plan participant, the company should watch for conflicts and lean on independent voices.
Pay that is too high can reduce company earnings and drag down the valuation that sets each employee-owner’s share value. Under audit, a corporation that overcompensates executives beyond the fair market value of services rendered can face tax adjustments and penalties. Pay that is too low carries its own risk, especially in S corporations. The fix is prevention: a documented, market-based analysis that shows pay reflects the actual services performed. That record is your best defense if anyone questions the numbers later.
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