Executive Compensation Has Attracted Serious

EXECUTIVE COMPENSATION has attracted serious debate and criticism in recent years particularly after the major fraud scandals rocked the American corporate world during last few years. It is one thing to see executives being awarded 'obscene' pay packages but it is even more difficult to see their inability to justify this heavy salary package with good performance. When senior executives and CEOs went home with the heaviest and biggest chunk of the profits and bonuses over and above their fixed salaries, most companies justified it with issues of motivation, turnover and retention. Apparently it was believed that if you pay executives more, they stay motivated and are driven to achieve targets thus lowering the turnover risk. However this logic and traditional wisdom no longer fails to satisfy the stakeholders who are now pushing for efforts to tie pay with performance.

An average executive compensation plan includes "an annual salary, an annual incentive bonus pegged to short-term corporate performance, a long-term incentive program typically structured around the issuance of stock options and a nonqualified deferred compensation program which supplements qualified retirement plan benefits." The costs associated with maintaining lavish executive lifestyle and compensation packages have resulted in a huge outcry from the public in general and stakeholders in particular. Many are now questioning the validity of motivation and performance claim. Baek & Pagan (2002) wonder if higher executive compensation actually increases performances: "The escalating cost of executive compensation packages has been of interest to researchers during the last decade. The median top executive compensation in S&P 500 companies has increased from a little over $1 million in 1990 to around $2.5 million in 1996...Moreover, the portion of total pay based on stocks and options also has increased from 30% to 50% during the same period." That was not just the case in the United States; such exorbitant increases in executive compensation have also been witnessed in Canada where a 2004 survey revealed that "Canada's top executives received an average increase in bonuses of 30% in 2003; at the same time, their base salaries increased by 6.3%. Moreover, the same survey revealed that including all forms of compensation, CEOs took home an average of about 8.3% more in 2003 than in 2002."

Ironically, salaries continue to rise for executives while other employees' do not witness any substantial increase in their wages. Apart from the fixed salary which is usually higher for executives than it is for the rest of the employees, the benefits and perks associated with senior level jobs have also come under severe criticism lately. Researchers feel that benefits are increased as fixed salaries increase so that they reflect the status of the executive. Studies reveal that while perks are directly connected with senior executive's stature, there is little logic in granting colossal benefits to those who are fully capable of paying for them with their fixed salaries: "Benefits, like salary, reflect the position of executives. If their total compensation is higher than for all other groups of employees, then benefit provision should be correspondingly higher. There is a kind of logic to this explanation. But there is also a kind of antilogic, too. Providing benefits to those most able to purchase such services themselves would appear to go against common sense."

Every firm has a compensation committee that determines the pay scale of each set of employees. This compensation committee may be composed of non-management staff and independent accountants who advise the firm about correct compensation determination. Stock options program was seen as a relevant and critical method of connecting executive interests with those of the shareholders. It was felt that if it was made mandatory for executives to participate in stock purchase, it would help them give their best to the firm. Their performance would increase since they would have a stake in the firm. It was the easiest way of keeping executives motivated and shareholders satisfied with compensation packages. However this program attracted immense criticism when it was found that CEOs were involved in insider trading and could cash in stock options before share prices actually fell in the stock market. "During the late 1990s, companies issued millions (and in the U.S., billions) of dollars worth of stock options, hoping to motivate their employees. Those days are likely over, for a variety of reasons, including shareholder concerns about the ever increasing dilution due to the issuance of options and new accounting rules requiring companies to expense options... In addition, studies have shown that the accounting cost of stock options exceeds employees' perceived value of those options. Finally, there has been a crisis in governance that has caused a reexamination of corporate accounting standards. No wonder some feel that stock options are dead in the water."

Compensation committees are now facing serious challenges. It is the job of the committee to have a valid, sound and sensible pay philosophy in order to determine compensation that best suits the company policy and shareholders interests: "...compensation committees must decide how to use a company's pay philosophy to best advance its overall business principles and goals."

Stakeholders are now expecting compensation to be closely tied with performance because it is felt that massive perks and salaries have a negative impact on company's profitability. Executives themselves are however against any such alignment since it spells risk and increased responsibility. If pay is aligned with performance as stakeholders expect, CEOs can expect variations in pay and to avoid such risks they are against performance-based pay system. It is widely believed that compensation committees do take into account performance indicators when determining compensation packages. Firms have been using performance measures regularly to create more sensible compensation system. These indicators include "stock return," "accounting income" and "cash flows from operations."

It is believed that employers must now find a more cost-effective way to keep the executives motivated and to enhance and improve their performance potential. Some researchers believe that one of these cost-effective measures can include "using a portfolio of stock incentives, including restricted stock units, performance share units and stock purchase plans, in addition to stock options." They feel that such measures can reduce accounting expenses while at the same time the compensation package so developed would have approval of other employees and shareholders.