Remuneration of Executive Directors - Case Study Example

Running Head: Remuneration of Executive Directors Remuneration of Executive Directors [Institute’s Remuneration of Executive Directors Introduction Globalization in the recent decades has been majorly detrimental to the health of several businesses on a global scale. Many lay off their workers, while others shift their resources around in order to prevent their losses from becoming chronic. While many such companies and their lower level employees suffer through such problems, the executive directors of several companies utter no complaints. However, this silence is less relevant to their leadership qualities, and more a result of their resultant extra ordinarily high salaries. In addition, there has been a very significant difference in the remunerations of CEOs belonging to US companies, as compared to those belonging to companies in the UK. With respect to this observation, this paper studies the remuneration of executive directors, and delves into the issues and theories concerning their outrageous amounts, and the debates that arise from them. The debate on the remuneration that executives receive has been carried out for several years. A recent factor, which has heated this debate even further, is the current recession and its effects (The Economist, 2010). This stems from the fact that over 13 percent of the residents of the US are unemployed, while millions others struggle to hold on to their jobs as their salaries and wages are reduced from what they used to be (Robbins, Judge & Judge, pp. 278, 2008). Apart from this, Lehman Brothers experienced a downfall, and needed two bailout packages from the government to recover and prevent further such happenings. This occurrence has made the common person wary of the way the scarce resources are employed, and that they should be treated as scarce instead of being wasted. However, people who only see half the picture make majority of the complaints and criticisms that the system of high remunerations receives. They see how these directors receive huge salaries for what they do, but they do not consider or even know about the stressful and demanding jobs that these directors do which help them secure such large payments (The Economist, 2010). This is a critical element that is missing from their perspectives, which makes theirs an unfair, unbalanced perspective. These critics do not bother considering the perspective of the CEOs themselves, or the significance and value of their services (The Economist, 2010). This paper aims to prove that, for this reason, their perception is flawed, and that the CEOs do earn the money they receive, using research, and statistics. Theoretical Perspectives It is an observation (Robbins et al., pp. 23-39, 2008) that a huge number of experts have carried out research on the issue of remuneration of executive directors in the United Kingdom, as well as in the United Kingdom, especially during the last decade. Analysis has identified that extraordinary increment in the salaries of executive directors been one of the major reasons of such a huge number of researches carried out on the subject. In order to understand theoretical perspectives of executive directors’ remuneration, the paper will include agency and expectancy theories that will provide a comprehensive understanding. In particular, every company in the United Kingdom follows a standard remuneration package for its executive director that usually includes a basic salary, a yearly bonus along with long-term benefits. In this package, salary is the permanent component whereas the other components vary in different organisations. It is an observation that two factors play a critical role in determining variable components in remuneration of executive. Firstly, the calculation that relates variable components as functions of basic salary (Robbins et al., pp. 23-39, 2008). The second factor refers to the achievement of directors in terms of their target, thus, an average performance will lead towards to a lower bonus. Besides understanding basic policies and standards of remuneration packages for executive directors, the paper will now use two theoretical lenses to understand the reasons of frequent changes in packages of executive directors that have been a major issue in the United Kingdom, as well as the United States (Robbins et al., pp. 56-64, 2008). These two theoretical approaches are agency theory (economics-based) and expectancy theory (motivation-based). In particular, agency theory offers limited perspective of the society; however, it can be very useful in understanding complexity of organisations. It is an observation that board of directors always look to relate remuneration packages with performance, and at this point, agency theory identifies remuneration package of executive directors as a tool to reduce the gap between shareholders and the directors, as by relating package with performance, it allows companies to acquire confidence of the investors, as well as shareholders. In this regard, agency theory (Beauchamp et al., pp. 30-47, 2008) suggests that by relating pay with the performance, it will automatically result in motivation of the executive directors. However, to evaluate validity of this supposition, expectancy theory can be useful. In particular, expectancy theory suggests that if companies use variable components as tools to motivate directors, it is very important that companies should provide an environment that may indicate possibility of fulfillment of targets. Secondly, it is essential that directors should receive the confirmation that fulfillment of targets will result in receipt of bonuses (Beauchamp et al., pp. 30-47, 2008). In other words, expectancy theory argue on the point that in such a case, probability or chances of achieving success will play a critical role in motivating directors to put efforts along with the magnetism of value of the bonuses. In this regard, experts (Beauchamp et al., pp. 30-47, 2008) suggest that from the perspective of expectancy and agency theory, it now becomes responsibility of the companies or board of directors to strengthen connection of efforts with performance, and relation of performance with bonus that is imperative theoretically. Issues One of the most common issues identified in available literature related to remuneration of executive directors is of extraordinary amount of their remuneration packages. Statistics show that this large differential between CEO salaries and those of an average person have existed for quite a while now. In the 80s, these CEOs of large corporations would receive 42 times more than the average worker, for every hour of work. By 1990, this tremendous figure increased further by almost 85 times (Kolb, pp. 77-79, 2006). By 2000, a CEO was making 531 times that of an average worker on an hourly basis. This study is a common reference made by those who criticize CEO pay. However, they avoid referring to the fact that CEO remuneration has decreased since 2000 by nearly 30 percent, especially due to the recession (The Economist, 2010). Another problem with this criticism of CEO pay is that the critics often present it without full knowledge of the facts. Mostly, these CEOs are paid in a combination of monthly salary, bonuses, and stock options. In addition, when research presents the remuneration of CEOs, it states the expected value of these stock options, rather than the much lower current values (Kay & Putten, pp. 59- 61, 2007). These stock options make up a considerable proportion of their compensation and are nor liquid, neither withdraw-able at any time. Thus, the actual proportion of their salaries, which is liquid or in cash form, is much less than what several resources quote (The Economist, 2010). Additionally, the critics fail to take into account that all jobs are paid salaries after considering their job description, and the job of CEO is no exception. The long hours, commitment, demanding nature and extreme sensitivity of the job of a CEO make him or her much more deserving of the salaries they get than the critics believe. There are skills required as well as the risk involved in the job, as proven repeatedly by history, which shows both the demise and the rebirth of companies due to their CEOs. A free market economist would be able to analyze this situation in a fair manner. High CEO salaries are a product of the mechanisms of the free market and its market driven forces (Beauchamp, Bowie & Arnold, pp. 158-159, 2008). This shows that there is no distortion or unfairness involved in the determination of these wages, and thus the free market can run its course with the wages it decides, without the critics raising question. If there were indeed a system in the determination of these wages, the board of directors of such companies would have brought down these executive salaries down to a relatively acceptable level several years ago. However, clearly they do see advantage in these rates of remuneration. Moreover, these payment rates are far from permanent for the CEOs. Critics often argue that these CEOs should be paid according to a pay for performance system, as lower level employees sometimes are (The Economist, 2010). CEOs in fact, face a much stricter payment system. The board of directors terminates them immediately if they do not perform at their jobs. Their performance is to retain their jobs, rather than to earn bonuses. AIG and RBS are both examples of such companies, having hired new CEOs recently with different remuneration plans. Furthermore, the valuable leadership that a CEO provides to their company justifies their payment, according to experts. Jack Welch, for example raised the worth of GE immensely after joining it as CEO. It went from having a net worth in stocks of 14 billion US dollars in the 1980s, to 500 billion US dollars today (The Economist, 2010). Experts agree that Jack Welch is the one who was responsible for this massive uplift of the company from good to great. If the company repays him with even half a percent of the value that he has added to the net worth of the company, the paycheck would amount to 2.5 billion US dollars (The Economist, 2010), whereas he received only a few millions for his accomplishment. Other examples of such transformational leaders are Jim Kilts and Steve Jobbs, each of whom have serviced their companies in a priceless way with their leadership. This can be viewed from a different perspective also. If a company’s board of directors has the option of purchasing a technology, which will boost company’s worth and change its fate for the better, the directors would be willing to pay billions of dollars for it without worrying about the debt incurred in the process (Bok, pp. 46-47, 2002). If this investment is justified, then by the same logic, so is that made in a good and promising CEO. If the person has valuable skills to offer, then other companies would automatically prove his or her worth by trying to get the person as leader for their own company. Thus, to avoid the hassle of replacing the CEO in the future, it is better to pay them highly in the present, to retain their services. Case Study Until now, the paper has discussed different theoretical aspects and current issues related to remuneration of executive directors globally. Now the paper will include example of a multinational organisation while discussing its policy for remunerating executive directors that will allow a practical understanding of the topic. In particular, the paper has chosen Sage Group Inc. (2011) that is one of the renowned global companies with millions of customers and approximately fourteen thousand employees in different parts of the globe. The company (Sage, 2011) mainly focuses medium-sizes businesses to offer products and services while catering huge organisations as well. Observations of company’s policy regarding remuneration of executive directors indicated that the company (Sage, 2011) has created a remuneration committee that includes board of directors that put efforts to create and alter remuneration policies in accordance to the international standards. Sage Group (2011) focuses primarily on the factor of performance to reward its executive, as well as non-executive directors, and thus, while relating this practice with discussed theoretical frameworks, the company seems to be creating policies in line with the agency theory. At the same time, in accordance with the suppositions of expectancy theory, remuneration committee of Sage (2011) endeavors to provide a motivational environment that may encourage executive directors to perform well in accordance with key mission and vision of the company. As discussed earlier about standard remuneration package of executive directors, Sage (2011) uses the same structure of basic salary along with annual and particular bonuses. The company claims to offer basic salary to their executive director that is similar to organisations working internationally in different parts of the globe. At the same time, the company offers opportunities to the directors to earn extra remuneration by performing extraordinarily in the company. In detail, Sage (2011)’s remuneration package for executive directors consists of basic fixed monthly salary; however, the company has set the month of October for review of salary’s amount, and thus, company ensures that executive directors receive salaries in accordance with existing international requirements. Besides fixed salary, the company offers particular bonuses to the directors that include health insurance, as well as travelling allowance, as well as a yearly bonus along with few long-term benefits that relate with the performance of directors. In addition, analysis of the company’s data (Sage, 2011) has indicated that the remuneration committee ensures that remuneration package guarantees achievement of organisational targets that was one of the major aspects of theoretical frameworks. In order to acquire confidence of the shareholders and investors, remuneration committee ensures that pay-for-performance bonuses may relate specifically with fulfillment of corporate objectives. In the result, the committee has been focusing significantly in depending on performance-related remuneration package for its executive directors. Lastly, Sage (2011) has been successful in maintaining consistency in the salary volumes; however, in the month of October 2009, there was approximately five percent increment in basic salary of executive directors. Conclusion Finance teaches us that the higher the risk involved with an investment, the higher the return. Thus, it is the job of any good business analyst to realize the worth of investment in a good and able CEO, even if it does cost more than the salary of an average worker. In particular, the paper discussed and analysed different aspects of remuneration of executive directors that will be beneficial in comprehensive understanding of the topic. References Beauchamp, Tom L., Bowie, Norman E., & Arnold, Denis G. 2008. Ethical Theory and Business. Prentice Hall. Bok, Derek. 2002. The Cost of Talent: How Executives and Professionals Are Paid and How It Affects America. Simon & Schuster. Kay, Ira T. 1998. CEO Pay and Shareholder Value: Helping the U.S. Win the Global Economic War. CRC Press. Kay, Ira T., & Putten, Steven Van. 2007. Myths and Realities of Executive Pay. Cambridge University Press. Kolb, Robert W. 2006. The Ethics of Executive Compensation. Wiley-Blackwell. Robbins, Stephen P., Judge, Tim., & Judge, Timothy A. (2008). Organisational Behavior. Pearson Prentice Hall. Sage. 2011. Remuneration Policy. Retrieved on May 01, 2011: http://www.sage.com/ourbusiness/corporategovernance/remunerationpolicy The Economist. 2010. 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