What Is CEO Compensation - Literature review Example

CEO COMPENSATION CEO compensation is a motive issue across the corporate world that hasattracted attention over the years due to the dubious deals that surround it. In the recent times, there have been rampant cases of corporate greed where the executives in organizations tend to award themselves huge pay packages coupled with abnormal incentives; thus, posing the question of the credibility and rationale on which these executives should be compensated (Oxelheim & Wihlborg, 2008). The factors that are considered in designing a comprehensive executive compensation program tend to be nearly similar in both the corporate and non-profit organizations (Lipman & Hall, 2008). However, pressure has been mounting on organizations from different spheres including the public that demanding for transparency & accountability in the way that the compensation packages are developed. That notwithstanding, legislation has also been enacted to regulate and streamline the whole process of executive compensation most notably through the introduction of internal revenue clause whose section 409A stipulates the regulations for all unqualified compensation schemes (Core et al., 1997). Good communication channels, coordination among all the stakeholders involved, and compliance to rules and regulations should govern effective compensation programs (Balsam, 2002). Therefore, for organizations to come up with good compensation programs, the whole development process should be an all-inclusive venture that involves all the stakeholders of the particular organization involved to ensure there congruence of policies and the adoption of a common approach that is acceptable by all people within the organization to avoid conflict of interest (Lipman & Hall, 2008). Considerations used traditionally to determine CEO compensation Executive compensation across all organizations is based on certain factors that tend to be similar across the board for all organizations. This is because organizations operate in business environments that are bound to common economic factors, which are affecting their operations (Balsam, 2002). Thus, these traditional considerations are more of a culture as they apply across the entire corporate spectrum. Some of them include the following; the degree to which an organization achieves its internal goals and objectives, the pay structure that an organization is implementing, the financial performance of an organization in relation to its competitors and finally the balance between the CEO’s pay and that of other executive employees (Core et al., 1997). The degree by which a corporation achieves its goals and objectives is a magnificent parameter to determine what to pay the CEO given that, they are the overall heads of the organization, and the success or failure of the company depends on their ability to manage it effectively and efficiently (Core et al., 1997). Thus, if an organization fails, the CEOs pay should be subjected to a pay cut, and if the organization depicts a positive financial improvement, a pay rise should be effected (Bebchuk & Fried, 2004). Corporate organizations tend to base their performance on their stock prices in the bourse, and hence considering that the prices fluctuate from time to time, it could be very hard to quantify whether the overall performance of an organization has improved, to determine if the CEO’s compensation should be increased or reduced (Lipman & Hall, 2008). A major critique to this consideration is that, the success or failure of an organization has little to do with the CEOs efforts, but is influenced by a number of coordinated factors that are even beyond the control of the executive. Therefore, this brings in the notion of rewarding executives based on luck and not their skills. Further, the executives can be learned individuals with distinguished academic credentials but organizational performance depends on other underlying factors rather than solely on the executive’s decisions (Bebchuk & Fried 2004). Therefore, it is prudent to say that, the hefty compensation packages awarded to executives are merely due to luck and not individual skills and expertise. In addition, it is common to find executives being awarded based on luck, when the organization’s performance increases but ironically, do not suffer any pay cuts when organizational performance declines i.e. when the organization’s performance surges, the executives do not undergo pay cuts to compensate for the poor performance (Oxelheim & Wihlborg, 2008). It is thus, evident that despite this consideration being an elite parameter of determining executive compensation, its mode of implementation is skewed and thus, cannot not produce the intended results (Oxelheim & Wihlborg, 2008). The compensation payment structure of the organization is another key consideration for determining the CEO’s compensation. Organizations have compensation structures that determine how they compensate their employees. However, all these structures must be consistent with the international standards & be in accordance with labor laws (Core et al 1997). Therefore, when determining the compensation of chief executives, these factors should be taken into account to ensure that whatever that is arrived at as compensation for the CEO, depicts consistency with the organization’s structure and is equitable when compared to the compensation of other employees of the organization (Lipman & Hall, 2008). The executive should not be advanced with hefty compensation packages while other employees are underpaid, but rather there should be an equilibrium to ensure there is equality in compensation for all employees of an organization (Balsam, 2002). A major criticism for this particular consideration is that, the terms of employment of CEOs are very different from those of other ordinary employees and thus, this gives them a leeway of obtaining extra incentives, which do not apply to other employees (Oxelheim & Wihlborg, 2008). For instance, executives make critical decisions for the organization and bear responsibility for such decisions, and thus, end up awarding themselves extra incentives to compensate for the risk they bear on behalf of the organization (Bebchuk & Fried, 2004). In addition, this consideration is criticized the ground that shareholders of the organization, in the case of public companies, are not involved in determining the CEO’s compensation, yet they are paid from their assets. Thus, they may tend to misuse shareholders’ assets in awarding unnecessary incentives to themselves (Oxelheim & Wihlborg, 2008). The performance of an organization may be on an upward index but again if compared with the performance of close competitors, the performance may be below par. Thus, an upward performance index is not a direct guarantee to reward CEOs (Lipman & Hall, 2008). A key criticism for this parameter is a scenario where all firms are underperforming, but one firm is leading the rest. In this case, this can be a justification for rewarding hefty packages to the CEO to appreciate him/her for better performance (Core et al 1997). However, Balsam (2002) argues that, given the organization is underperforming although it is ahead of its competitors is not a justification for better performance because it has not achieved the objectives and goals for which it was formed. On the other hand, Lipman & Hall (2008) argue that, different organizations have different objectives; thus; it is imprudent to compare the achievements of one organization to another given that their objectives are different. For instance, one corporate organization may be a product oriented while the other may be consumer oriented. Thus, the performance of these two firms cannot be quantitatively compared hand in hand (Core et al., 1997). The other factor, which is considered when developing the compensation program for corporate CEOs, is the balance between the packages of CEOs and those of other top echelons. Decision-making is not a one-man affair, but involves other top leaders (top-level managers and other managers) in an organization. Therefore, the compensation packages of CEOs should not portray a wide disparity as compared to those of other key management officers (Bebchuk & Fried, 2004). This parameter is qualitative and equally rewards the executives in consideration with other management officers whom they share responsibilities with hence eliminating the notion of rewarding the executives heftily at the expense of the others (Balsam, 2002). However, this consideration can be criticized account that, it promotes harmonization of compensation programs of only top corporate officers at the expense of other junior employees leading to a wide gap in compensation between the executive and the ordinary employees (Core et al., 1997). Sample evaluation tool Variable Representation Assumed Effect Academic credentials AC + Leadership roles LR +/- Innovation skills IS + Firm’s performance FP +/- Share holders’ right protection SHRP +/- CEO age CA +/- CEO tenure CT +/- Firm size FS +/- Relative market performance RMP +/- Quality of corporate governance QCG +/- This evaluation tool is open for implementation across all industrial firms as it takes into account all the factors pertaining to corporate executive remunerations. A wide scope was taken into consideration, and iterative sampling conducted to narrow down the factors considered, which are the major factors that influence corporate compensation schemes (Core et al., 1997; Balsam, 2002). The business environment despite being dynamic faces similar factors that influence its operations. Thus, all corporate firms despite the kind of business activity they undertake, they are prone to be influenced by similar factors inherent in their environment and thus, this makes it possible for the evaluation tool to be implemented by firms across the corporate divide (Lipman & Hall, 2008). Role of technology Technology has been a pivot factor in the 21st century as it has revolutionized the manner in which business operations are conducted. Thus, to gain a competitive edge over other market players, firms are struggling to obtain innovative technologies to enhance invention and innovation in their business operations (Bebchuk & Fried, 2004). Therefore, the need for technology has grown exponentially to levels where it has become almost a basic need for business growth. In the context of factors to be considered in developing compensation programs for CEOs of organizations, technology can play a vital role in not only coming up with the initial consideration factors but also help in processing, analyzing and quantifying these factors to obtain quality and accurate results (Balsam, 2002). In addition, technology serves to solve the problems that are associated with the traditional method. For instance, technology will help in carrying out quantitative analysis of the consideration factors to provide output that can be easily be related and implement in developing compensation schemes by providing accurate and consistent output, which is reliable in developing efficient compensation programs. Therefore, this implies that the chance of bias will be eliminated because all the factors to be analyzed, will be subjected to the same parameters (Core et al., 1997). Challenges that face use of technology The greatest challenge that would face the use of technology in evaluation is the lack of goodwill from the top echelons of management who will not welcome it, as it will harmonize executive compensation in accordance to the compensation structure of the organization (Balsam, 2002). Further, lack of relevant skills to effectively use and interpret the results from technological tools will be another setback. The results may also be misinterpreted thus, giving the wrong impression of the analyzed factors (Lipman & Hall, 2008). Technology just like the business environment is very dynamic and thus, demands the willingness of the organization to invest continuously in new and better forms of technology. This may be a burden to some firms, especially small sized organizations, which do not enjoy the economies of scale like large well-established corporate firms hence leaving them with no option other than sticking to the cheap traditional methods of determining CEOs compensation (Bebchuk & Fried, 2004). Further, human resource management is governed by strict rules ®ulations that must be adhered to. Therefore, whenever an organization wants to come up with a new technology to boost the efficiency of developing compensation programs, the human resource management must verify and ensure that the technology in context complies with the HRM regulations (Balsam, 2002). Thus, given the high threshold that these regulations set, which moderate technology innovation cannot match, and the sensitivity nature of executive compensation programs, it, therefore, becomes a problem to implement (Lipman & Hall, 2008). Relevance of factors in future The modern world is on a gradual change and thus, the decisions that are made today cannot solve problems in the near future e.g. in the next five years. Therefore, the same case applies to these factors; they may be binding presently but be irrelevant in the near future (Core et al., 1997). However, there is a principle rule when coming up with an efficient compensation program; an allowance for change that must be made to accommodate future changes. Thus, with these, the factors can be manipulated overtime to stay at par with the market trends and technological changes (Balsam, 2002). Therefore, executive compensation is a sensitive issue and thus, whenever an organization wants to come up with an effective compensation program it should conduct a joint venture with all stakeholders to explore all factors (Core et al., 1997). This will assist in ensuring that everything pertaining to compensation program is considered conclusively, and the factors that should be settled for consideration are consistent with the existing organizational compensation structures to depict a sense of equity in relation to other employees’ compensation. References Bebchuk, L. A., & Fried, J. M. (2004). Pay without performance: The unfulfilled promise of executive compensation. Cambridge, MA: Harvard University Press. Balsam, S. (2002). An introduction to executive compensation. San Diego, Calif. [u.a.: Academic Press. Lipman, F. D., & Hall, S. E. (2008). Executive compensation best practices. Hoboken, N.J: John Wiley & Sons. Core, J. E., Holthausen, R. W., Larcker, D. F., & Wharton School. (1997). Corporate governance, CEO compensation and firm performance. Philadelphia: The Wharton School, University of Pennsylvania. Oxelheim, L., & Wihlborg, C. (2008). Markets and compensation for executives in Europe. Bingley, UK: Emerald. 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