Executive compensation concerns the remuneration of top executives in corporations. The executive compensation is a package that includes base salaries, bonuses etc. The top executives negotiate for their employment contracts. These contracts are typically five years and they spell out basic salaries, target bonus- that is paid with or without guarantees, and the severance procedure in case of separation and the change of control in the company (Murphy, 1). The executive compensation has been rising and there is a big difference between wages paid to top executives and other workers. This paper will look at the executive compensation packages, executive pay, criticisms and how the top executive should be paid.
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Executive compensation packages
Executive compensation goes beyond the package that the senior executives get. It also includes tax laws and securities that control the stock incentives. It also encompasses the terms of executives’ employment. On the other hand, it has been argued that executive compensation is determined by the executives so as to get the maximum pay. The argument goes on to say that the executives’ compensation has contributed to financial crisis by encouraging the managers to take too many risks for the sake of short-term benefits.
The top executive’s pay has increased and it has outstripped that of other employees by far. For example in 1991 a Chief Executive Officer (CEO) got 140:1 times that of an average employee while in 2003 the ratio was 500:1(Bebchuck & Friedman, 1). The pay has generated an interest from investors, financial regulators the public, the media etc the higher the pay the more interests it generates.
According to studies done United States top executives are paid higher than their counterparts elsewhere in the globe. The total amount paid to a representative CEO is more than two times of the average pay for a CEO elsewhere. A more interesting point from the study is that United State executive’s pay is different from CEOs elsewhere. They get a larger portion of their packages in terms of stock and a smaller portion in terms of salaries compared to their global counterparts (Murphy, 1).
There is the base salary for the CEO which is normally determined via competitive benchmarking that is based primarily upon industry salary survey. The survey has pay percentiles for instance 25th, 50th and 75th which are adjusted according to the company’s size by size groupings or log-linear regressions. Size is typically evaluated by using the company’s revenues albeit the use of market capitalization that is on the increase (Murphy, 9).
The use of surveys has many implications in levels and trends of executive compensation. First Murphy suggests that size adjustments formalize as well as reinforce the relationship between the compensation package and the company size. Second, pays that are below the 50th percentile are considered below market and those that range between the 50th and 75th percentile are said to be competitive thus the surveys have a major impact on the base pay levels.
Third, the surveys do not have the criteria many economists consider as very relevant in determining the earning levels for example, experience, performance, education and age. They consider company size which is an imperfect for substitute job complexity, span of control and the managerial skill requirements. Thus the base pay levels are based on the target percentiles than incorporated criteria (Murphy, 9).
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Therefore top executives devote their attention in determining their salaries. This is because the base salaries form a key component in their employment contracts. In addition the base salaries are the basis upon which the executive compensation is measured. For instance target bonuses are given as a percentage of the base salaries, other benefits and severance measures depend on the base salary levels (Murphy, 10).
This has led to a lot of criticisms and many people have expressed concerns that the CEOs are paid a lot of money for the services they provide. That notwithstanding the executive compensation is vital in the running of a company. Normally the compensation package is set by the board of directors though the executives exert pressure on the salary contract (Murphy, 1). Thus creating the controversy about the high pay packages for the CEOs as some companies go under.
In some countries the government has taken a stand on the issue of executive compensation. For instance the US government set a limit on bonuses that top executives can receive on firms that received assistance from the economic stimulus package in 2009. The executives should not get more than a third bonus of their yearly salaries. However some feel that this would hurt the private sector by having the government meddle in its affairs. Some firms would only end up employing low paid workers to maintain the perks for their executives who would otherwise look for employment elsewhere (Narayanan, 1).
Remuneration of top executives
The pay package should be attractive and have effective incentives. This would attract CEOs and motivate them to work for greater performance of their companies. Narayanan observes some companies perform dismally albeit the CEOs getting big packages. This can only mean the executive compensation needs to be overhauled (Narayanan, 1).
Executive compensation in many companies depends on the financial returns in the short-term. The returns are got from the implementation of the strategic plans of the company. Thus the executive compensation should be geared towards improving the organization of the company to improve the performance (Narayanan, 1). The packages should attract the right top executives to implement the corporate strategy. For example they could offer salaries below market that are coupled with aggressive pay that is connected to the individual’s performance. This would probably attract self-motivated individuals for the job.
Performance of the company can also be improved by giving the CEOs longer tenures. When a CEO is scared of being sacked for failing to realize short term financials they do not focus on long term thus the corporate is unable to reach its long term objectives. This calls for a board that is willing to actively participate in formulation as well as implementation of a corporate’s strategy. It should also compensate the CEO for all implementation milestones and monitor the long term performance of the corporate. This type of board is more likely to appreciate the efforts of a CEO even when they do not meet the financial results in the short term.
The boards therefore need to start evaluating the CEO’s annual performance to gauge their long term objectives. At the same time the board should be actively involved in succession planning so as to avoid a scenario where they end up looking for a “megastar” CEO to come and rescue the corporate from its financial problems. It is in situations like this that enable the incoming CEOs to bargain for contemptible executive compensation packages (Narayanan, 1).
It is important to look at the executive compensation practices. They need to be adjusted to avoid hurting the economy of a country as well as the corporate. Executive compensation should be based on long term performance by spreading the benefits e.g. bonus over a long period of time. This would remove the fear of the executives being sacked for failing to meet short term financial goals of the corporate thus focus on improving the performance of the company to achieve its long term objectives. More importantly is that the reforms should come from the board and executives of companies (from within) rather than external. When this happens can they act in the best interests of their companies rather than on selfish personal gains at the expense of both the shareholders and the company.
Bebchuck, Lucian Arye & Friedman, Jesse Pay without Performance. The Unfulfilled Promise of Executive Compensation. Cambridge: Harvard University Press, 2006. Web.
Business week. Narayanan, V.G. 2009. Getting Executive Compensation Right. Harvard Business. Web.
Murphy, J. Kevin. 1999. Executive Compensation University of South California. Web.