Executive Compensation in Federal Agencies - Essay Example

Executive Compensation in Federal Agencies s Problem: The Federal agencies seek to reorganize their executive workforce need advice on executive compensation given their statutory limitation Executive summary There have been debates regarding in the manner in which executives need to be remunerated. Executive compensation comprises of monetary compensation as well as other non-monetary rewards that are received by executives from their organizations for their service delivery. The Federal employees are salaried based on the guidance set by the Government-wide regulations. Even though there is a very weak correlation between executive pay and performance, over the past three decades, executive compensation has been on dramatic rise. In this regard, the federal agencies have also been competing with public and private companies for the scarce executive talent. Excessive executive compensation has a negative effect on the society. However, the federal agencies have reorganized their executive workforce based on their statutory limitations with regard to executive pay including progressive taxation, independent remuneration committee, bonus-malus system, and having a supervisory body to vote on executive pay. Introduction and background Every employee needs to be compensated. Executives in the organization are also paid for their services. As cited by Balsam (2012), executive compensation consists of non-financial rewards as well as financial compensation that are received by an executive from their firm for their services to the organization. Corporate pay is a crucial component of corporate governance. In the federal agencies an executive can a corporate officer, such as, president, deputy president, head of department, chairpersons’ board of committees or any other manager middle or upper-level in any organization. The levels of compensation for the executive workforce in all nations across the globe have been increasing rapidly over the past decades both in absolute terms and relative terms. In 2012, the globe’s highest paid chief executive officers as well as chief financial officer were all from the United States. There are five pay rates within the Executive Schedule from Level I to Level V. Proponents of high executive pay argue that the global war for talent explains the tremendous increase in executive pay. The defenders further argue that the increase in executive pay is a just a derivative of the demand and supply of executive talent. On the contrary, most of the American executives earn considerably more that what their Asian and European counterparts get paid. In the U.S executive compensation has outpaced economic growth along with average compensation for all workers since the 1990s. Executive workforces earn 400 times as compared to the average worker. Pursuing this further, America has also the world’s highest chief executive officer’s compensation relative to manufacturing production employees (Bebchuk & Fried, 2011). Figure 1: Growth of executive pay (Balsam, 2012). There is still debate on if the rise in executive pay is due to competition for scarce business talent which can add significant value to the firm or socially harmful idea that was as a result of political and social changes which have given executives more control over their pay. Question to be addressed According to Simms and Boyle (2010), the distorting effect of on the economy of massive executive bonuses is evident. The justification for higher executive pay is that it is a motivational effect on the senior executives as well as the aspiring middle-level executives. A study by Equilar Inc. found out that nearly 40% of the top 0.2% income earners in the U.S were state executives, company executives, managers, or supervisors. One way of evaluating executive pay is comparing compensation against performance. The dramatic increase in executive pay growth is indirectly proportional to growth in productivity if measured by earnings performance as shown below. Figure 2: Reflections of executive compensation (Bogle, 2008). Federal Reserve Board also argues that the level and structure of executive compensation in US is largely unresponsive to tax incentives. Therefore, the question to be addressed is how the United States Federal agencies seeks to reorganize their executive workforce and require ways in which it will determine its executive compensation given their statutory limitation Framework and available information There has been a remarkable increase of executive compensation in the past four decades. The changes in executive pay can be explained by changes in performance, organization size, and industry category. Executive compensation in the U.S differs from other employee compensation in the form it takes, regulations and laws it is subject to (Ellen & Lynch, 2011). Like other employees in the modern U.S, executives receive various types of non-cash and cash payments or benefits that are offered in exchange for services including fringe benefits, bonuses, salary, deferred payments, severance payments, and retirement benefits. The executive schedule for the federal employees range from Level I to V. Seyhun (2008) argues that the upsurge in executive compensation was brought on, partly by the sharp decline in the top marginal income tax rate. The federal laws as well as the securities and exchange commission (SEC) regulations have been formulated in relation to compensation for the top executives in the last few years, for instance, a $1 million limit on the tax deductibility in addition to a requirement to take account of the dollar value of compensation in a standardized form in yearly public filings of the organization. Possible solution paths with conceptual and factual support The analysis would use a quantitative approach by reviewing relevant literature on executive compensation in federal agencies, reviewing government documents, as well as academic documents on executive compensation. It has been found out most executives’ pay is on the rise. This may be attributed to the competition of scarce managerial labor in the market. SEC provides all the information about executive compensation in the public fillings (Kuepper, 2014). The executive workforce is paid using various form including base salary, incentive pay with a short term focus, incentive pay with a long term focus, extra benefits and perquisites, deferred compensation, and enhanced benefits package which comprises of a Supplemental Executive Retirement Plan (SERP), as well as option grants. The superiors’ decisions often affect directly the productivity of lower levels employees. Therefore, sorting more able people into higher level positions will result in higher marginal productivity of people at higher levels in the federal agencies. Contrarily, there is a very weak relationship between pay and performance. Eriksson (2006) adds that based on the tournament theory, executive pay has little to do with the performance of the executive workforce. It has also been found that the larger the number of people in the managerial position regarded to have significant responsibilities in the organization, the larger is the compensation spread. Recommendations There are various strategies which the federal agencies could use in response to the growth of executive compensation: having an independent remuneration committee that will ensure the pay packages are set at arm’s length from the directors getting paid; updating the policy on contractor executive salaries to incorporate the applicable methodology to fully document reasonableness determinations. making sure that procedures and policies are closely followed when determining the executive salary during pre-award and post award of contracts (U.S Department of Energy, 2013); having a maximum wage which an executive can legally make in addition to a minimum wage so that the executives are not paid too little (Fried, 2007); the pay setting to take into consideration the grade of the position, years of experience within that grade level; suitable salary table of the position, and performance of the employee in the position; progressive taxation which is a more general strategy which influences executive compensation in addition to other highly paid individuals. Bebchuk and Fried (2011) argue that executive compensation can be checked through taxing heavily the highest income earners; abolish the practice of having a joint chief executive and chairman of board of directors and come with independent bosses who will instead oversee the boards; the bonus-malus system where the executives carry down-side risk together with the potential up-side reward; debt-like compensation which alleviates the risk of shifting tendencies; finally, having a supervisory body which votes on executive pay (Chance, Kumar, & Todd, 2010). Future considerations In future, executive pay needs to be aligned with performance. This is because there is a very weak link between executive salary and performance. If a performance-based payment system is adopted for the federal employees in addition to the set government-wide regulations, the performance of federal agencies would improve. Conclusion Summarily, executive compensation is a very crucial issue for the federal agencies if they are to retain the scarce executive talent. An improperly remunerated executive may cost the government’s money as well produce an executive who lacks the drive to improve the agencies operations. However, there is a very weak relationship between executive pay and performance. Meanwhile, the Federal government is working to curb this problem with new laws which will close loopholes in executive pay and performance and making the process more transparent. This makes the public more informed as well improve performance in the federal agencies. References Bebchuk, L., & Fried, J. (2011). Pay without performance: The Unfulfilled Promise of Executive Compensation, New York: John Wiley & Sons. Bogle, J. (2008). Relections of CEO Compensation, New York: Academy of Management. Balsam, S. (2012). An Introduction to Executive Compensation, San Diego, CA, Academic Press. Chance, D., Kumar, R., & Todd, R. (2010). "The Re-pricing` of Executive Stock Options,” Journal of Financial Economics 57(2), 148. Ellen, M., & Lynch, (2011). "An examination of Executive Stock Option Re-pricing," Journal of Financial Economics 61(9), 209. Eriksson, T. (2006). Executive Compensation and Tournament Theory: Empirical Tests on Danish Data. Aarhus: Centre for Labor Market and Social Research. Krugman, P. (2007). The Conscience of a liberal, New York: WW Norton & Company. Fried, J. (2007). "Reducing the Profitability of Corporate Insider Trading through Pretrading Disclosure," Southern California Law Review, 71 (1998) 322–323. Kuepper, J. (2014). Evaluating Executive Compensation: Retrieved November 25, 2014, from http://www.investopedia.com/articles/stocks/07/executive_compensation.asp Simms, A., & Boyle, D. (2010). The New Economics: A Bigger Picture. New York: Routledge. Seyhun, N. (2008). Investment Intelligence from Insider Trading, Cambridge, MA: MIT Press. U.S Department of Energy. (2013). Approval of Contractor Executive Salaries by Department of Energy Personnel. Washington D.C: United States Department of Energy. Read More