Executive Pay and Reward Systems in the Finance Sector - Coursework Example

Executive Pay and Reward systems in the finance sector (Insert Name) (Insert Course) (Instructor’s Name) (Institution Name) 1st November 2011 Table of Contents Table of Contents 2 Introduction 4 Assessing individual performance 4 Consultation of job description 5 Communication with the directors 5 Feedback system 5 Executives coaching programs 6 Analyses of director’s weaknesses and strengths 6 Developing executives 7 Meetings and appraisals 7 Performance review 7 Quantitative measurement 8 Updating the directors 8 Proper documentation 9 Rewarding director’s performance 9 Reward System 9 Theories of the Executive Remuneration 11 Firm performance and Principal-Agent 11 Managerial Discretion and the Task Complexity 12 Chief Executive Officers Variables 13 Corporate Governance and the External Ownership 13 Salary increment 14 Flexible working hours 14 Social event 15 Annual awards 15 Free days 15 Positive feedback 16 Conclusion 16 References 17 Introduction The profitability and the success of an organization largely depend on the productivity of all the stakeholders including the directors and the managers. In order to face off their competitors in the market, many organizations have taken initiatives to highly reward their directors in order to make them more devoted on their duties. There are two major types of director’s motivation. The first one is the extrinsic motivation. These include motivation aspects that come from external sources for example salary increment, promotion and grades. The second one is the intrinsic motivation. These include internal factors that ensure increased productivity by a director. For instance, self satisfaction and passion of doing a duty. In order to ensure effective motivation for the directors of organizations, it is essential to emulate proper strategies of assessing individual performance. This paper seeks to analyse the executive pay and reward system particularly in the financial sector. Assessing individual performance The role of directors in an organization cannot be overlooked. This is based on the fact that they are directly involved in the management of the organizations. Due to poor methods of evaluation, some organization rewards the directors who are not hard working while good performers are left unnoticed. Even though the good performing directors do not necessarily get demotivated, poor evaluation may result to loss of company financial resources. Directors are in most cases assessed in terms of the time taken to carry out a particular task, quantity of the material used, costs incurred and the quality of their jobs. It is essential for companies to obtain analyze and record the productivity level of the directors. This is undertaken through regular performance appraisals. (Archer North & Associatiates, 2009).The section below indicates the major way of assessing individual performance. Consultation of job description It is vital for the managers to keenly consult the responsibilities of the directors as outlined in their job description. This should be followed with aligning the objectives of the job with the objectives of the entire organization. Any discrepancy that is noted by the managers is brainstormed in collaboration with the directors so as to streamline the performance of their duties (Cofer et al, 1967). It is worth to note that the involvement of the employees in solving a problem is not only an avenue of assessing their ability to address complex issues, but also is extrinsic factor of motivation that finance mangers should emulate. Communication with the directors It is prudent for financial managers to regularly communicate with directors regarding the expectations of the management. Thomas (1987) stipulates that through such communications, it is possible to achieve a common understanding between the directors and the managers concerning the nature of the work and jobs expectations. It is vital to note that due to poor communication system within many financial organizations, some directors especially who work on part time have inadequate information concerning the performance of their companies. Feedback system It is fundamental for the manager to offer feedback to the company directors regarding their performance. Such feedback should be related to the goals set by the management. Fishbein and Ajzen (1975) argues that even though the managers are able to evaluate the level of directors compliance to the preset objectives of the company, most directors are still in a position to assess themselves by use of the feedback as the base of assessment. It is also essential for the managers to be honest and constructive on their feedback to avoid demotivating the directors. Executives coaching programs In order to modify the director’s performance, it is necessary for the managers to provide relevant resources and guidelines to ensure that the directors meet the expectations of the management. Managers must assess whether or not the costs incurred in the coaching process justify the results depicted by the directors. In case of discrepancies, managers should evaluate the effectiveness of the coaching process on the director’s productivity in order to reduce on the costs. Analyses of director’s weaknesses and strengths Financial managers need to analyze the weaknesses and strengths possessed by the directors. This can be done by use of self evaluation forms or a checklist. Based on the fact that top executives have different strengths and weaknesses, it is paramount for the managers to inform the executives what is the bases of their conclusion. In this way, company directors are in a position to correct any problem or deviation that affects their performance. Directors who portray higher level of devotion need to be highly rewarded in order to motivate other employees to improve on their performance. Developing executives The various positions within the financial organizations calls for different level of skills and experience in order to face off the challenges faced in managing and allocating financial resources. In this regard, companies should decide the best education programs and career that will enhance the productivity of the executives (Murphy, 2009). Meetings and appraisals Director’s performance is also assessed through appraisals and regular meetings with the financial managers. During such meetings managers are in a position to encourage and monitor the director’s progress. In the same way, part time directors are able to freely intermingle with managers thus encouraging exchange of views and ideas that are essential for the development and the success of organizations. It is paramount for the financial managers and the directors to set targets and come up with strategies to achieve the targets. Regular top executives appraisals are also appropriate techniques of assessing their performance (Thomas and Jane. 2004). Performance review Managers should initiate a legal performance review process that is not biased. In order to ensure the review process is effectively carried out, it is vital for companies to hire qualified personnel to undertake the appraisal process (Seligman and Martin, 1990). Some of the aspect that makes the appraisal process illegal and ineffective includes biasing the directors on the basis of race, religion, color and nationality. Quantitative measurement Even though it is a challenging task, quantitative measurement of director’s duties is a paramount strategy that managers should adopt. Some of the measuring aspects that managers can use includes, profit per director and time demoted by each director to attend company functions. In addition to the director’s appraisal, measuring of the director’s performance is paramount especially when managers are contemplating on renumerating the hardworking directors. Another tool that can be used to evaluate the directors is the timesheet. By filling the time sheet, directors indicate the number of hours they dedicate per month to complete projects that are under their jurisdiction (Steinmetz, 1983). In this way, managers can identify the implications of the directors on the success of the final project. This is also helpful in identifying the various aspects that hinders the performance of the directors and the cause of delays on the completion of a project. Updating the directors In order to ensure that directors are aware of their duties, it is essential for the financial managers to regularly update the directors on the changes that positively or negatively affect the performance of the organizations (Garderner and Lambert .1972). In addition, to the manager’s appraisal, it is vital for the directors to maintain a record that depicts their input. In this way, managers can undertake a comparison of the records thus making it possible to detect any variation. Due to the regular changes in the fields of accounting and finance, managers should give their directors weekly updates on the important economic aspects that can affect the profitability of their organizations (Whyte and Cassandra, 2007). Proper documentation Due to lack of proper and updated appraisal documents, some directors experience problems during their evaluation. It is therefore prudent for the managers to ensure that collect information that concerns the directors performance are maintained. Such record should indicate the major accomplishment that has been undertaken by the directors as well as the necessary training required to improve the overall performance (Terrence, 2004). In addition, managers should be directly connected with their directors in order to have an effective communication. In this way, it is possible to regularly update the employees on the various changes that occur in their organizations. Rewarding director’s performance In order to ensure that the director’s performance is improved, it is vital for the managers to emulate effective rewarding system to motivate the directors. As stated earlier, motivation can be extrinsic or intrinsic (Cioppa 2010). Reward System The issue of global financial crises has resulted to massive media attention regarding the issue of compensation to directors and other senior executives across the globe. As indicated by Bolton (2010), extravagant spending on notable areas, such as payment of high salaries to the directors, raised cost of transport within the organizations, among other notable forms of fringe benefits offered to directors across the branches. For multinational organizations like the British Airways, General Motors, among other notable organizations, the issue of executive pay has been linked to the collapse of these firms, since the onset of global financial crises in 2008 (Frydman 2010). However, the aspect of reward system has remained an issue of contention in the financial sector even prior to the onset of the global financial crises. For instance, financial institutions like the Royal Bank of Scotland (RBS) had to be bailed by the United Kingdom government in an effort to rescue the bank from collapse. Ciamarra (2010) argues that reward system is the rules, procedures and the standards that are associated with the allocation of compensation and benefits to the directors. Executive compensation in the financial sector and other related corporations started to soar in the early 1990s. After the financial economic crises that occurred in 2007 and 2008, large pay packages have become the main point of public fury, especially when they are paid to executives of firms receiving the taxpayer funds. In countries like the United States of America, public fury and media attention to those firms offering hefty pay to their executives have been a point of focus, in the last one month. This has resulted to massive demonstrations in the Wall Street, referred to as Occupy Wall Street Movement all in protest of greedy companies and other forms of inequalities being experienced in the country. As indicated by the US president, Mr. Barrack Obama, executive pay packages has encouraged the excessive, which led to practices responsible for the current financial crises. Despite the efforts of different governments across the globe to reduce on the pays offered to the executives, it has remained hard to control this rise. This is because their bonuses have continues to increase at a significant rate. For instance in 2010, the overall compensation for executives in the financial services increased by 5%, with employees working in other businesses like asset management receiving more than 15% rise (Bolton 2010). Theories of the Executive Remuneration Ciamarra (2010) indicates that financial companies are often homogenous in most of operational characteristics, thus offering almost same levels of compensations to their executives. Within the financial sector, there are three main notable subgroups namely the commercial banks, insurance companies, brokerage and the non-depository institutions. Although, these subgroups are homogenous in their operations, they still differ not only on the primary services, but also in their institution tradition and regulatory environments. Previously, various models of compensation such as pay-for-performance relations for institutions like commercial banks were used. The method indicates that the sensitivity of pay for the executives increased in 1980s after there was deregulation of the commercial banks in various places across the world. It is worth noting that numerous theories regarding the pay for executives have been developed all in an effort of streamlining the pay offered to them (Bolton 2010). Firm performance and Principal-Agent The economic theory of pay to executives focuses on design of the optimal schemes of compensation in order to align with the interests of shareholders and managers. The agency theory identifies numerous factors through which the interests may differ. These include the levels of effort put by managers and the problem that results from unobservation of relevant skills of the agents. The design of the optimal compensation contacts the trade-offs between various incentives problems as well as considerations of risk sharing. Newman (2008) has also directed the identification of the proper performance standards aimed at compensation and evaluation. One of the common concerns that have been expressed in this approach is the inappropriate yardsticks to performances, which can result to strong incentives to wrong actions. Although both market return and accounting measures can be considered as one of the method of compensation for the top executives, none of the two methods has been considered as an appropriate method of compensation. From the perspectives of shareholders, returns obtained from stock exchange are generated from changes in stock price and are not defined in terms of accounting terms. Further, accounting numbers are usually ex-post measures, thus can only be related to the attainment of performances. In contrast to this, market-based performances, reflects the actions by the managers as they induces future growths in the profits. Therefore, measuring the performances of managers based on the shareholder returns can be subjected to significant fluctuations of the market, which are not accountable or controllable by the managers. It is worth to indicate that earnings-based incentives cannot suffer from these problems, thus shielding managers from the noises that are associated with fluctuations in stock markets and are beyond the controls of individual managers. Ciamarra (2010) indicates a significant relationship between the stock market rates of return and CEO compensation. It considers the element of RET (Total Shareholders Returns) and ROE (Return on Equity) as the main points to be considered when determining the compensation rates for the executives. Managerial Discretion and the Task Complexity In the parallel strands, research indicates that in strategic management, managerial strategic discretions and complexity of the jobs they carry out are the vital aspects to look for when considering compensation for the executives. Newman (2008) agues that the managerial discretion is the task complexity and latitude off the options owned by top managers when making strategic choices. Managerial discretion can also be defined as the extents to which a firm can form as well as fit within the controls of the top management. The central point to this particular concept is views that higher levels of discretions, higher potential impacts of the actions, which is taken by CEO on the organization. Based on this argument, the levels of the executives compensations as well as use of incentives for compensation purposes will ultimately be higher that is in line with the insights of agency theory,. This is on the use of the subjective measure, given the challenges found on measurement of performance. CEOs operating in industries that are more regulated have less discretion in the strategic choices, although in the financial sector, the degree of regulations greatly varies within the three subgroups (Rosen 2007). Chief Executive Officers Variables There is the need to account for the chief executive officers specific factors. To start with, the managerial tenure can be employed when determining the level of compensation. However, Frydman (2010) argues that the tenure of CEOs can have a reduced mobility, thus reducing their bargaining powers. The other aspect is the managerial stock ownership, which is probably one of intricate way to determine the compensation level. Ciamarra (2010) points out that, relationship between an organization performances and degrees of the management share ownerships is mostly non-monotonic. At the lower level managerial shares offers better congruencies of interests that are outside shareholders. As the share ownerships increases, the executive’s gains tighter control, thus they can engage in the non-value activities of maximization (Schultz 2009). Corporate Governance and the External Ownership The importance of the corporate governances usually arises because managerial employment contracts fail to resolve agency problems from separation of the control and ownerships. In complete states of verification as well as the prohibitive cost, make it impossible for the shareholders to come up with strategic choices of an organizations and managerial actions. Instruments of corporate governance, which are used when augmenting for managerial contracts, are institutional share ownerships, possibilities of takeovers, presence of large outside blockholders in shares, effectiveness of the board of directors among other notable factors. In countries, such as the US, U.K among others, state and federal legislations have significantly restricted transactions in ownerships and it excludes the bank acquisitions by the non-financial organizations. However, critics of corporate governances suggests that putting large numbers of the insiders being on the board, minimizes the control of the board, hence reduced control pay offered to the CEOs among other executives (Bolton 2010). Salary increment Due to the stiff competition, that has engulfed the finance sector; many organizations have adopted salary increment in order to avoid losing their productive directors to the competitors. In addition to the monthly remuneration directors should also be rewarded through bonuses and commissions. This is based on the fact that most of the directors perform extra duties for the benefit of the company. Due to the recent economic downturn that affected many countries, the ability of many organizations to increase director’s salaries was adversely affected. This resulted to adoption of other motivational aspects by financial entities as discussed in this section. Flexible working hours Flexible working schedule is an important reward that financial managers cannot overlook. Due to the long duration of time, the top executives engage in their duties, most of them do not have ample time to be with their families. In this regard, it is vital for financial organizations to provide the directors with free time in order to enable them address their private activities such as doctors’ appointments and banking services (Frydman 2007). Social event In order to boost the morale of the directors, it is necessary to create social events in a weekly or monthly basis. It is vital to note that the busy schedule of the permanent directors limits the opportunities through which they intermingle with the managers. Through the social events, managers are able to freely forward their grievances to the top level directors. In the same way, directors can effectively assess the performance of the managers. A good example of a company that propagates holding of social events is Cisco incorporation. Annual awards Top executives can also be rewarded through annual awards. Even though not all the ideas from the directors are effective, it is fundamental for organizations to recognize directors who contribute ideas that are focused at improving the productivity of companies. By awarding directors for their ideas, their spirit of innovation is escalated. As a result, the opportunities for the company’s growth are enhanced. Free days The provision of days off to the directors is also a strategy that financial institutions should emulate as a reward. Due to the many working hours that permanent directors devote for their organization, they lack adequate time to be with their families. This may result to poor family relationship. It is important to note that poor family relationship is one of the major factors that affect the productivity of company stakeholders including top level executives. In order to avoid reduction of director’s productivity, it is advisable to offer them off duties without being concerned how they will utilize them (Bebchuk 2005). Top level executives involvement in projects management In addition, to increasing director’s remuneration financial institution should give top level executives chances to pick their own tasks to accomplish a given project. This does not only motivate the directors, but also it makes them to work hard in order to ensure the success of the entire project. Since managers do not posses all the skills needed to accomplish a particular project, the involvement of both part time and permanent directors ensures that diversified ideas are adopted leading the success of a project (Lands kroner 2011). Positive feedback Positive feedback from the managers is an important aspect of director’s motivation. During workshops and meetings, managers should acknowledge the roles played by the company directors. Even though by not giving positive feedback directors are not demotivated, it reduces the chances of working hard by directors. According to Ciamarra (2010) managers can use words such as I appreciate it; it makes me feel good among others in their positive feedback to the directors. Conclusion The productivity of the top level executives is a major determinant of the profitability of an organization. In this regard, business entities and especially financial institutions should initiate proper strategies of assessing the top executives. Some of the major aspects of evaluating the directors include assessing their performance based on the job description, communication and consultation as well as providing feedbacks. Based on the above discussion, performance review should be regularly undertaken to detect variations and obstacles that affect the top executive’s performance. In the same way, directors should be updated on the appraisal results and any information regarding their performance be communicated to them in a timely manner. From the above information, one can see the urgent need to regulate the compensation offered to the executives. This is because of the fact that the recent global financial crises affected financial performance of many organizations especially in the finance sector. References Archer North & Associatiates, 2009. Introduction to Performance Appraisal, Retrieved from http://www.performance-appraisal.com/intro.htm Bebchuk, L 2005, The Growth of Executive Pay, Harvard University press, Harvard. Bolton, P 2010 , Executive Compensation and Risk Taking, Sage, Texas. Ciamarra, E 2010 , Executive Compensation and Risk Taking: The Impact of Systemic Economic Crisis, Harvard University press, Harvard. Cioppa,P. (2010). Executive Compensation: The Fallacy of Disclosure. Macmilan, Canberra Cofer, N; Appley, Mortimer H .1967. Motivation: Theory and Research, New York: Sydney: John Wiley & Sons Fishbein, M.; Ajzen, I. 1975. Belief, attitude, intention, and behavior: An introduction to theory and research. MA: Addison-Wesley Frydman , C 2010, Learning from the Past: Trends in Executive Compensation over the Twentieth Century', Center for Economic Studies, Texas Frydman, Y 2010, Historical Trends in Executive Compensation 1936-2005, Rutledge, London. Garderner and Lambert .1972, Attitudes and Motivation in Second Language Learning, Rowley, MA: Newbury House Landskroner Y, 2011, The 2007-2009 Financial Crisis and Executive Compensation: An Analysis and a Proposal for a Novel Structure. Sage, New York. Murphy, J. 2009. Inner Excellence, McGraw-Hill, Newman, R 2008 , "Banks make money from employees' life insurance". NorthJersey.com. Retrieved 2011-10-18. Rosen, T 2007. Who Killed Katie Couric? And Other Tales from the World of Executive Compensation Reform', (2007) 76 Fordham Law Review 2907 Schultz, E. 2009. Banks Use Life Insurance to Fund Bonuses. The Wall Street Journal. Retrieved 2011-10-18. Seligman, M.E. 1990. Learned Optimism, New York: Alfred A. Knopf, Inc Steinmetz, L. 1983. Nice Guys Finish Last: Management Myths and Reality. Boulder, Colorado: Horizon Publications Inc. Studenski, P. 2009. The Income of Nations; Theory, Measurement, and Analysis: Past and Present, New York University, Press New York. Terrence H. 2004.Performance Appraisals. London: Sage Thomas F. 1987. Refining Performance Appraisal. London: Sage Thomas, Jane. 2004.Guide to Managerial Persuasion and Influence. NewJersey.: Pearson Prentice Hall. Whyte, Cassandra B. 2007. An Additional Look at Orientation Programs Nationally. National Orientation Directiors Association Journal, vol. 15, no. 1, pp. 71-77. Read More