Executive Compensation Programs Term Paper

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Executive Compensation Programs and Incentives

In 1996 the average salary plus bonus for CEOs was $2.3 million. After other benefits were added, this sum rose to $5,781,300. Beginning with Revlon executive Michael Bergerac who broke the $1 million mark in 1974, executive pay and bonus plans have soared to mind-boggling proportions. Although various governmental agencies have set limits on tax-deductible executive compensation, these efforts not only failed but served to raise the bar on executive compensation even higher (Milkovich and Newman 455). In general, the CEO of a corporation makes at least twice as much as the next highest paid executive and 35 times the salary of the average worker (Bogie 118). This pay disparity becomes even more alarming when bad leadership causes mass layoffs and shareholder losses even as top executives continue to receive their oversized pay.

Executive compensation consists of five basic components: 1) base salary, 2) annual incentives / bonuses, 3) long-term incentives and capital appreciation plans, 4) employee benefits, and 5) perquisites (Milkovich and Newman 458). The exact proportion of this mix will rely on the executive's position within the organization. For example, CEOs will often have their benefit packages weighted toward long-term incentives given that their decisions affect the long-term positioning of the organization while vice presidents compensation packages will often lean toward short-term incentives (Bohlander, Snell and Sherman 414).

Executive base salaries are usually dependent upon other executive salaries in the same field. This salary is usually determined in part by a survey of salaries in comparable companies ordered by the board of director or other compensation committee. In the automotive industry, CEO salaries average out at approximately $814,000 (Bohlander, Snell and Sherman 414). Executive base pay will also be dependent on the type of organization, the size of the organization and geographic location of the company. In general, an executive's base pay makes up approximately 40-60% of annual compensation (Mathis and Jackson 479).

When compensation committees are made up by the board of directors problems can arise given that many of these individuals lack expertise in compensation matters. In such cases, the committee usually leans toward the plan proposed by the CEO who has hired an outside consultant to advise on compensation matters. According to Graef Crystal, a former compensation consultant, it is considered politically incorrect to ignore the CEOs recommendations. "If things get bad enough, you can fire the CEO. But until you do, you'd better support him. Indeed, about the only time I have seen a board attack a CEO on his pay has been when it has already decided to get rid of him"

Bogie 113)

Short-term performance incentives are based on the executive's individual contribution to the company. These bonuses may be based on a percentage of the organization's total profits or a percentage of profits in excess of a specific return on stockholders investments. Other plans include basing the executive's bonus on specific objectives set forth by the board of directors and agreed to by the executive. Like other employees within the organization, executive bonuses may be tied to performance ratings for achievement (Bohlander, Snell and Sherman 414).

Short-term bonus plans are designed to motivate better performance. Two decades ago, annual bonuses for executives were given by approximately 38% of U.S. organizations, while today the number of organizations giving annual bonuses is closer to 90%. For many industries, these bonuses make up a significant portion of the executives total compensation, in some cases, as much as 72%. For example, in the financial industry annual bonuses are 2.5 times higher than base pay yet only 38% of base in the utility industry (Milkovich and Newman 460).

Long-term incentive and bonus plans can make up a substantial proportion of the executives total compensation averaging around 35% in most cases. While executive stock options are still the most common form of long-term incentives, there overuse and abuse has drawn a heavy barrage of criticism. One complaint is that this type of incentive pay does not pay the executive for performance as payouts are often based on general market increases rather than the specific actions of the CEO (Milkovich and Newman 460). The common belief is that tying the CEOs or executives pay to stock performance will lead to that individual acting in the best interest of share owners. For this reason, the board of directors will usually award executives with stock and stock rights and in some instances, require the executive to purchase stock

Bogie 122).

A problem with stock options is that many executives exercise their option and sell the shares immediately for profit so that there is little incentive to create long-term increases in share prices. According to Huddart and Lang, "90% of the stock acquired by exercising [stock options] was sold immediately" (Bogie 124). Also, "some executives sell before exercising by shortening the stock ahead of exercise time and then, after exercising, using the optioned stock to cover the short sale" (124).

Other long-term incentive plans include phantom stock plans, restricted appreciation rights, performance share/unit plans, and nonqualified stock options. Phantom stock plans center on a cash or stock award determined by increases of the company's stock price at a predetermined future date. The income earned is taxed as ordinary income. Restricted stock plans are grants of stock with the condition they may not be sold before a specific date. In this case, the excess over fair market value is taxed as ordinary income. Performance share/unit plans involve cash or stock awards earned through the achievement of specific goals, and are taxed as ordinary income. Nonqualified stock options involve allowing the executive to purchase stock at a stipulated price regardless of current market value. As with restricted stock plans, the excess over fair market value is taxed as ordinary income (Milkovich and Newman 461).

Executive perquisites, or perks, vary from organization to organization. The main things these perks usually have in common are their nature of rewarding those who have risen to the top of the corporate ranks. These perks may be internal, meaning that they are meant to provide a little extra something while the executive works for the company. Internal perks include luxury office space, special parking, and executive dining rooms (Milkovich and Newman 461).

Other perks are meant for the executives use outside of the office such as company-paid memberships to clubs and associations, company car, company plane, chauffeur service, legal counseling, low interest loans and more (Milkovich and Newman 461-462). Although these perks are company paid, various tax and regulatory rulings require organizations to place a value on them so that their value can be included in the executive's taxable income (462). The number and value of perks offered are often viewed as a status symbol both inside and outside of the organization (Mathis and Jackson 480).

Executive benefit plans for CEOs resemble those of other company employees in structure and include health insurance, vacations, and retirement plans. In addition, executive plans will often include elements not found in the regular employee benefit package such as no co-payments on health insurance, no limitations on deductibles or physician choice, and corporate-owned life insurance on the life of the executive (Mathis and Jackson 479-480).

Golden parachutes" is a term for very large sums of severance pay offered to retiring or forced out CEOs and executives (Dovring 20). Additionally, golden parachutes provide protection and security to executives in the event other firms acquire their firms. Current estimates indicate that over half of all CEOs and other senior executives are covered by such programs. The typical golden parachute will give the executive a lump sum equal to 2-4 times his/her annual salary and bonus as well as outplacement assistance, immediate vesting of stock options and other sweeteners. Other golden parachute programs provide consulting contracts at the final annual salary and bonus for up to 10 years in addition to the above (Mathis and Jackson 484). Examples of such elaborate retirement and/or severance packages can be seen in recent history. The retirement package of John F. Welch of General Electric was valued at $122.6 million while Steven P. Jobs of Apple Computer was given a corporate jet valued at over $90 million (Lavelle).

Deferred bonuses, often included in long-term incentives, can be used to provide the sole source of retirement benefits, or to supplement a pension plan. Many organizations use Supplemental Executive Retirement Programs (SERP). A typical SERP might state that the organization promises the executive a benefit of 60% of final pay which will be offset by 100% of the benefit provided by the employer's qualified plan (Bohlander, Snell and Sherman 415). Executives may also have the same type of pension and retirement plans as other employees within the organization. For instance, the executive may participate in the organizations 401 (k) plan, which allows him/her to save through payroll deductions matched by the corporation at a predetermined percentage of the executive's contributions. These plans differ from traditional retirement plans in that they guarantee nothing. Actual savings available at…

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