What Is Executive Compensation - Essay Example

?Employee Reward Table of Contents Table of Contents 2 Introduction 3 Executive Compensation 3 Literature Review 7 Analysis & Discussion 10 Conclusion & Recommendations 13 Reference List 14 Introduction Executive Compensation Executive compensation (EC) also known as financial compensation is received by a compensation officer of a firm. The compensation includes salary, bonus, shares, company’s stocks, perquisites and other forms of benefits (CIMA, 2010). Executive compensation is also regarded as a total rewards umbrella and also the company’s strategy as a whole (CIMA, 2010).The executive total reward system and model sets a separate framework and context for executive compensation (Conyon, 2006). The executive compensation system helps in the improvement of the existing system that helps in accomplishment of goals and objectives. A well structured compensation system helps in the attraction of dynamic and talented pool of executives who can help the company in gaining competitive advantage over its competitors (Browning, 2012).An integrated approach of designing a reward structure helps in developing a system which is directly related to the growth of the company . Executive reward system in a company is the result of a high level interaction between the company executives and the director to maintain an acceptable return on the investment at all times. The executives expect some kind of salary based on daily or annual basis. It also includes employment contracts, portable retirement benefits and deferred compensation (Haygroup, 2013). The company management instead wishes that the executive achieve specific goals and also include developing capabilities (Edge and Davis, 2004). A well constructed EC system is only feasible with the development of a leadership framework in which the responsibilities, duties and capabilities are clearly identified and sorted out as per the executive level. In the leadership framework the level, responsibility, capability and results are clearly defined which helps in identification of the opportunities and the development of a strategy. The traditional executive compensation system was developed by Mirrlees and Holmstrom in the year 1975 and later it was modified by Holmstrom and Tirole in the year 1993 (Haygroup, 2013). This theory was developed to help in building an incentive scheme which focuses on trade-off risk sharing and incentive, reward consideration. The theory was also formulated keeping in mind whether the management would be able to pay back the invested amount or not. The author laid emphasis on the fact that stock prices not only reflected the fundamental value of the organization but also signified a short term speculative amount. The various constituents of the executive reward systems are as follows: Direct Pay Base Salary The entire executive system would include the annual based salary which would be replaced by the executive salary plans. As per the leadership framework the executive total rewards system would be as follows. Base Salary Annual Incentives and Perks Long Term Incentives Career Development Responsibilities Short Term Success Long Term Success The capability and short term success would be considered The executive salary planning would start as per the market pay data and the desired competitive range would be decided based on the competitive performance of the executives. It also includes the inputs and growth in individual responsibility and the high level performance for the individual (Armstrong, 2002). The salary plans are developed on the assumption of the consistent performance for the executive reward system. Annual Incentive The executive reward system, annual incentive plan also forms an important part of the total reward and incentive system for the executives (Lepak, 2013). It helps in benchmarking the total work as per the quantitative and qualitative performance standards (Lepak, 2013). To ensure individual accountability the incentive system is designed in such a way that executives are able to accomplish the goals and objectives in a structured format and also obtain the bonus amounts, incentives and rewards. Long Term Incentives The individual accountability that is applied in individual bonus would apply to the long term plan and also the long term incentives. One of the most long term incentive plans would be the stock option which does not recognize the individual leadership and provides an opportunity which is related to individual contributions Income Continuity Plans Income continuity plans provide a foundation for the companies and the executive to make large amount of capital investment plans even during a short period of time. One of the major elements is portability which provides income security and continuity for the executive. The total executive rewards system would help in providing support to the entire executive system and also providing an income protection. Restricted Stock Awards The restricted stock award and subsequent appreciation of funds that help in developing a portable retirement benefit system that will include benefits for employees and managers (Armstrong, 2002). The company’s contribution is in the form of restricted stock functions which are similar to the supplementary contribution plans (Sigler, 2011). The supplementary contribution plans helps in stock appreciation. This kind of stock ownership programme allows the basic interests of the shareholders and the executives which is ready to converge (Sigler, 2011). It has certain limitations like the share and stock ownership and the organization cannot be determined easily. In that case only an incentive system helps the management to accomplish certain goals and objectives for a defined and extended period (Desimone and Werner, 2011). The compensation package system will contain exclusive benefits like deferred payments, perks and incentives etc. The dispersed ownership helps in the emergence of contracts and also the development of pay setting contracts (Desimone and Werner, 2011). Severance Contracts The severance contracts are an important part of the contractual agreement between the corporate and executive officers such as control of agreements or employment contracts. The most critical part of the executive plan would be income protection and emphasis on the change of control agreements and employment contracts. EC helps in designing a package which also encompasses elements like tax and securities law that helps in control of stock incentives and adhere with the employment agreement plans. The moot point of EC managements system would be considered after evaluation of other factors and deciding upon the pay setting process. The executive compensation system is developed after taking guidance from the stakeholder and agency theory which is decided by the board of directors and the management in unification. Literature Review Executive Compensation in the United States of America, European Union & Australia The executive management system in the US is largely dependent on the functioning of the Securities and Exchange Commission (SEC) and the regulations established by the SEC. The proxy statements developed by SEC contain details about the stock ownership, options and the other components of compensation of the top five corporate executives. The evidences related to the top five corporate executives would be analyzed from their work and the success of their contribution would be observed through the performance of the company. Information like share ownership, benefits, salaries, restricted stock awards etc is used to assess the managerial performance (Cagney and Sirkin, 2000). There are various components of the salary structure of the CEO in US Corporations; base salary, annual bonus, incentives, stock options and additional compensation (Cagney and Sirkin, 2000). The executive pay in UK corporations has increased considerably since the 1990’s especially in the equity based performance. Although, the current economic slowdown in the UK has instilled fear or sense of insecurity among the employees for getting paid less or no incentives, the compensation payment system has altered slightly in most of the corporations. The high levels of compensation provided to the executive CEO are also largely influenced by the market dynamics and is not always linked to the performance and management of the executive CEO. The EC system has been largely influenced by the dynamic principal agent model theory. This model generates a certain amount of competing characterizations of the executive pay received by the top level managers (Patti, Fok and Hartman, 2000). The agency costs that are generated by the non alignment and mismanagement of the executive and shareholder’s interests in the dispersed ownership company contribute to the effectiveness of the system. The equity based performances and share options received by the executives will have a direct impact on the shareholder’s wealth and incentives received by the company management. The agency model has impacted the business activities of the European corporations to a large extent (Fisk and Thomas, 2006). The incentive and pay system is largely influenced by the equity based pay model which is simple and the simplicity of the model lies in the regulations and policy systems. The current economic slowdown has led to confusion while designing a well defined pay and regulation system. The present economic slowdown in UK has led to several other conflicts regarding the designing of the pay setting structure, disclosure and governance which may require the interference of the government systems (Armstrong, 2000). The structure of the equity based performances has revealed a number of inefficiencies related to effective corporate governance and disclosure in pay setting. The structural challenges and difficulties related to pay setting poses problems to the UK corporations given the internationalization of the executives in the market. However, the average salary range of CEO working in mid cap companies of the SBF 250 Index had significantly dropped by 17 percent in the year 2010 which stood at a market valuation of €511,000 (ECGS, 2013). 12 CEO of leading organizations had lowered their annual salary range keeping in mind the current economic situation (ECGS, 2013). The chart given below will reflect the annual salary received by CEO of leading organizations in the year 2012. Annual Salary CEO Name €10.7 million Jean Paul Argon €9.7 million Bernand Arnault €9.5 million Carlos Ghosn €7.7 million Bernard Charles €6.2 million Maurice Levy €6.1million Christopher Viehbache (Source: ECGS, 2013) The CEO compensation system has been one of the heated debacles in Australia because the structure of the pay setting system is not based on the interaction between the executives or directors but their contribution in generating the annual turnover. The Australian corporation is largely influenced by the agency and stakeholder theory (Hall and Lipman, 2008).The level of pay and incentives has been clearly defined by the shareholder’s and the stakeholder’s. It has been observed that the CEO remuneration system is designed in such a way that the organizational interest is aligned with the personal interest of the employees. The compensation system is largely influenced by the agency theory which contributes effectively to the performance of the executive and top level managers. As per a recent survey conducted by the Merhebi and Kerry Pattenden it was observed that the performance of the CEO is directly related to the size of the organization (Merhebi, et. al., 2006).The agency theory is largely consistent with the compensation, organizational performance and the overall pay structure of the employees (Merhebi, Pattenden, Swan and Zhou, 2006).The CEO and the executive performance is largely dependent on the size of the organization because of the salary range of the employees of the organization. In Australia the remuneration received by the employees is decided by the legislation which was introduced in the year 1986 and requires the disclosure of director’s identity and their desired remuneration including the remuneration of the top five highest paid executives. The legislation act enacted on 1st July 1988 play a pivotal role in the design of the pay setting structure of the top level managers in USA, UK and Canada (Merhebi, et. al., 2006).These disclosures incorporate salaries, fees, benefits, fringe benefit taxes and superannuation packages. Analysis & Discussion Comparison of Executive Compensation System between the different sectors & Gender in Australia, European Union & United States of America In American multinational corporations the base salary is benchmarked against the top competitive companies so that the employees can understand the pay setting structure easily. Secondly, annual bonus plans provided to the top executives would be based on the accurate accounting performance measures and systems. The top executives would receive the stock options which signify the right but not the obligation to purchase shares at predetermined prices (Fisk and Thomas, 2006). Finally, the salary would also include the additional compensation system like restricted stocks, incentive and retirement plans (Fisk and Thomas, 2006). It has been observed that the there is a strong link between the salary received by the top executives and the performance of the company. It is also regarded that the designed incentive plan in the US corporations would require analysis from external consultants in assessing the risk factor and value of the system. One of the major risk factors associated with compensation management would be the encouragement of the opportunistic behaviour of the managers and manipulative behaviour of the performance measures. As per the survey conducted by ‘The Courant’ it was observed that out of 66 Connecticut companies, the average CEO payment amounted to $6.3 million during the tenure 2011 to 2012 (Haar, 2013). In the year 2012 the Connecticut CEO were earning an average of $13.6 million, compared to the year 2011 where the CEO were paid only $6.3 million (Haar, 2013). As per the findings it was observed that the CEO executive compensation system did not vary from female to male CEO or top level managers. In Australia the Australian Securities and Investment Commission were developing strategies that would help in the construction of a pay setting structure and would make CEO risk averse because of their heavy investment in human capital resources and also the adverse impact on the performance of the CEO. As per the survey conducted by the Matolcsy it was observed that the pay performance sensitivity case was directly related to the accounting procedures of the organization. There is a positive relationship between the performance of the CEO and the remuneration received by him/her. In Australia the CEO is directly related to the performance of the employees in a magnitude compared to the others. Whereas in the European Union the corporations have fixed remunerations which come in the form of performance shares or stock options which have amounted to 30 percent of the total compensation (Shin, 2013). The leave and the pay structure are composed in such a way that the rewards and incentives are distributed as per the performance of the individual employees (Rahimi, Damirchi, and Seyyedi, 2011). One of the prime objectives behind the alteration in the pay and incentive structure is the imbalance generated by an universal banking model that needs to be revitalized through a great amount of accountability of managing directors which is also affected by good corporate governance. The remuneration was decided by taking into consideration factors like annual vote on remuneration, information of the yearly pension cost and the readable performance of the data. The female executives were liable for additional incentives and benefits like maternity leave and child care incentives unlike the male executives. Thus, as per the findings it is observed that in the multinational corporations of US, Australia and European Union the executive pay system is also an integral part of the business model and the perceptions of the management. Most of the managers and leaders get share options, which have the potentiality of creating powerful incentives and diverging shareholder interests. These can provide incentives and maximum shareholder’s value which can affect the managerial decision making to a large extent. The salary structure of the employees, top level managers and the executive CEO differs from different sectors in Australia, European Union and USA. The Australian oil sector is one of the most well sector and the employees, managers are much more than those working in the US and European Union corporations. The average salary of the executives working in the Australian oils sector would be AUD 60,000 compared to the average salary of the executives working in the US corporations. It was observed that the executives and the top level managers working in the US retail and accessories departmental stores are highly paid and are paid according to their contribution in the annual turnover generated by the company (Kuntz and Smith, 2003). The average salary and benefits received by most of the employees was almost equal to $29688 in the year 2012 (Kuntz and Smith, 2003). However, the average salary in defence and energy sector soared in the Australian and US corporations where the total salary was equal to the $6.7 million. Although, the women representation in the top level position is almost minimal in most of Australian, US and European Union corporations it has been observed that there is a minimal gap between the salary received by the women and men executives at the top level position especially there are women employees in the executive compensation committee. According to a survey conducted by the Sage Pub in the year 2010 it was observed that women constitute only 2 percent of the CEO committee in the US corporations and 16 percent of the directors in the Fortune 500 companies (Shin, 2013). It was also observed that a significant amount of gender gap existed between the executive compensation and this also largely because of the small portion of the women employees in the top level position. As per the findings there is no difference between the salary received by the women executives and directors in different sectors of the economy in most of the Australian, US and European Union corporations. Conclusion & Recommendations An implication of the analysis of the compensation management system is the failure to maximize the shareholders wealth and the value which is an indicator of the weak corporate governance mechanisms (Bolton, Xiong, and Scheinkman, 2006).The prime objective of the management would be to provide a mechanism for the investor’s speculative motive which would help the management for investment purposes for the betterment of the organization. A proper framework needs to be developed which focuses on recruitment of talented executives, key performance indicators, provision of alignment between management and shareholder’s and reinforce the organizational culture. Reference List Armstrong, M. 2002. Employee reward. London: CIPD Publishing. Armstrong, M., 2000. Managing people: A practical guide for line managers. London: Kogan Page. Bolton, P. Xiong, W. and Scheinkman, J., 2006. CEO compensation and company performance. Review of Economic Studies, 73, pp.577-610. Browning, H. 2012. Accountability: Taking ownership of your responsibility. North Carolina: Center for Creative Leadership. Cagney, L.K. and Sirkin, M.S. 2000. Executive compensation. New York: Law Journal Press. CIMA, 2010. Executive Remuneration Schemes and their Alignment with Business Sustainability. [online] Available at: < http://www.cimaglobal.com/Documents/Thought_leadership_docs/CIMA%20Executive%20remuneration%20schemes%20and%20sustainability.pdf >[Accessed 01 August 2013]. Conyon, M.J. 2006. Executive Compensation and Incentives. [online] Available at: < http://www.lse.ac.uk/fmg/researchProgrammes/corporateFinance/corporateGovernance/pdf/executiveCompensationAndIncentives.pdf >[Accessed 01 August 2013]. Desimone, R.L., and Werner, J.M. 2011. Human resource development. London: Cengage Learning. ECGS, 2013. CEO Remuneration in Europe’s. [online] Available at: < http://ecgs.com:8080/node/59 >[Accessed 01 August 2013]. Edge, J. and Davis, M. 2004. Executive Compensation: The professional's guide to current issues & practices. San Diego: Windsor Professional Information. Fisk, P., Miles, G. and Thomas, M., 2006. The complete CEO: The executive's guide to consistent peak performance. New Jersey: John Wiley & Sons. Haar, D., 2013. CEO pays for 2012 in state, country part of broken system. The Courant, [online] 15 April. Available at: < http://articles.courant.com/2013-04-15/business/hc-haar-ceo-pay-afl-cio-20130415_1_ceo-pay-executive-paywatch-afl-cio [Accessed 01 August 2013]. Hall, S.E., and Lipman, F.D. 2008. Executive compensation best practices. New Jersey: John Wiley &Sons. Haygroup, 2013. Executive Rewards. [online] Available at: < http://www.haygroup.com/ww/services/index.aspx?id=110 >[Accessed 01 August 2013]. Kuntz, P. and Smith, E.B., 2003. Top CEO Pay Ratios. Bloomberg, [online] 30 April. Available at: < http://go.bloomberg.com/multimedia/ceo-pay-ratio/ >[Accessed 05 July 2013]. Lepak, D. 2013. Human resource management. New Delhi: Pearson Education India. Merhebi, R., Pattenden, K. Swan, P.L. and Zhou, X., 2006. Australian chief executive officer remuneration: Pay and performance. Accounting and Finance, 21(2), p.481-497. Patti, A.L., Fok, L.Y. and Hartman, S.J., 2000. Differences between managers and line employees in a quality management environment. International Journal of Quality & Reliability Management, 21(2), p.214-230. Rahimi, G., Damirchi, G.F. and Seyyedi, M.H., 2011. Surveying of organizational culture and management behaviour affect in organizational innovation. IDOSI Publications, 14(11), p.1763-1769. Shin, T., 2002. The Gender Gap in Executive Compensation. The Annals of the American Academy of Political and Social Science, [e-journal] 639(1). Available through: http://intl-ann.sagepub.com/content/639/1/258.full#ref-6 [Accessed 05 July 2013]. Sigler, K. 2011. CEO compensation and company performance. Business and Economics Journal , 31(2), pp.01-08. 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