Effectiveness of Executive Compensation Scheme - Assignment Example

EXECUTIVE COMPENSATION SCHEME Executive compensation Scheme also known as ECS is termed as the total incentives which are given by a firm to an executive member of their staff like any Chief Executive Officer or also known as CEO. Good ECS can basically helps a lot in order to reduce different kind of the agency problems and they also align the interest of the shareholders also known as the owners and also the executives or the agents. With regards to this above mentioned information, this paper basically discusses whether or not an executive compensation scheme or also known as ECS are inherently flawed and also the disclosure requirements of the executive compensation scheme or ECS. The traditional and the particular view of ECS is only to attract to motivate and also to retain all the qualified personnel. The Tournament theory on the other hand further supported this view and also suggested that, a small and a minute difference in ability basically leads towards the high compensation. In simple terms, this definition basically fails to consider the main and the important significance of the executive compensation scheme or ECS in the overall governance of the organizations, for instance how and why these kind of different bonuses are basically awarded and what actual benchmark is used.  ECS have basically four main and important components which are 1. The base fixed salary. 2. The stock options. 3. The long term incentive plans. 4. The annual bonuses which are usually being monetary or shares. All the stock options are normally based on the company's overall performance. Although the presentation and the features of the stock option is usually vivid and clear, the exact amount of the compensation can also be unclear as the amount could have been set many years ago and the share prices may also have changed. Furthermore, the executives may circumvent this in order to improve their performance with the help of accounting decisions in the earlier years before the turnover, which basically increases the reported results, or with the help of income-smoothing practice, which basically borrows the income from the future.  Bonuses are basically shown separately to the share options in the company proxy statements. Although the cash compensation and all the other types of the compensation are disclosed separately in different other places like footnotes it is therefore termed as the complexity of the separation that can usually cause the reports to be more unclear for all the shareholders long term interest.  This basically suggests that the executives wield at least some kind of pressure on both the level and also on the structure of their compensation.  For instance most large US firms have a well organized remuneration committee which basically consists of two or more two outside directors.  Although all the major decisions which are related to the top-level compensation are passed through this organized committee, the committee then rarely conducts the market studies of the competitive compensation levels or the initiates or they proposes new ECS or the executive compensation schemes. (Bolton & Dewatripont, 2005) In a research which was carried by Standard & Poor’s Executive compensation database data stated and concluded that the compensations may be higher due to the weaker corporate governance. This basically suggests that the managerial power can basically lead to the use of an ineffective executive compensation scheme or the ECS which consists of the compensation schemes that weaken or can also distort the incentives and therefore can also reduce the shareholders value.  This on the other side also suggests that the top executives in the modern company cannot be always trusted; therefore the executive bonuses can be well explained as the result of the wielding massive influence of CEO over the board of the directors who are eventually responsible for determining and selecting the executive compensation schemes and programs.  This view is furthermore supported by the managerial power approach which also suggests that the directors who have more source and who also have more power than their boards will automatically receive higher compensation as compare to the other ones. However many other researchers take the view as an economically bull market, shareholders should also accept some of the huge compensation arrangements that would also provide a high-powered incentives and will also aligns the interest of the shareholders along with their managers. Apart from this, throughout the last two decades, the shareholders have repeatedly acknowledged and noticed the increase in the compensation of the directors as the price of improving initiatives of the managers. However, much more additional value was provided to the directors has and that value was not actually been linked to their own individual performance, but rather to the organization’s performance or no performance. This also suggests that, the shareholders have not received yet as much wealth creation and also the transparency as possible in return for their own investment. Furthermore, it also contradicts the basic and the main underlying principle of an executive compensation scheme or ECS and it also creates more kinds of the agency problems. In the Agency problem, directors may also take actions that basically increase their personal well being as compare to the wellbeing of the public and also of the shareholders. The Agency problem is also known as one the major and also one of the main problem as it is directly related to the working of a person in any organization, and if the working is being affected then automatically the executive compensation scheme will be affected and therefore all the managers will suffer. In order to be safe from this kind of situation the managers and especially the executive always try to work hard and also to work safe so that they can gain more and more without facing any kind of problems. (Bolton & Dewatripont, 2005) Executive compensation techniques basically provides a great chance for all the managers, seniors and also for all the executives in order to perform well so that they can gain more and more and can acquire more and more. Executive compensation scheme on the other hand is also known as one of the classic agency cost problem. Although all the CEOs and also all the other executives are regarded as the agents of that particular corporation in which they are working and also its shareholders, they have the main power and also the main incentives to shirk. Indeed, they have also those incentives with the help of which they can easily behave opportunistically i.e., to maximize their own normal and also important perks and also their own wealth at the expense of their own principles of the shareholders. Accordingly, the executive compensation schemes should be designed in such a way that can easily constrain the shirking and also can constrain the opportunism; in other words, the executive compensation schemes should strive hard in order to align the executives' interests with those of the shareholders. These kind of executive compensation schemes plays an important role for each and every single firm because with the help of this a manager can basically acquire what ever he/she wants by doing and by providing best quality work.  However on the other hand all the academics believe that the executive pay has been always overstated and has always been flawed and therefore the executive compensation scheme or the ECS have been very much limited to the small number of the firms since the executives are not being motivated by money in the first place, but rather than ego and also by fame. Others also believed that many different kind of flaws in the executive compensation schemes or also known as ECS have been widespread, but these kind of flaws have also been resulted from the honest and also from the true misperceptions and also by true mistakes. However, various economists assumed that the pay arrangements are the product of the arm’s-length negotiations between the boards who are seeking in order to get the best possible deal for their shareholders and all the executives who are attempting in order to get the best possible deal and the best possible result for themselves. This main and important assumption has also been consider as one of the best underlying principles for all the corporate law rules which are basically governing the main subject and also the agency theory. However, it is also claimed that the pay-setting process in the investment banking system has also been strayed far from the arm’s-length model therefore the contradicting agency theory and also the economist assumption in the process are very much important. Furthermore, the compensation of the executive directors is often been decided by the directors themselves and they also identifies that they does not require any kind of an approval from the share-holders. They believe that it is not even that much necessary to identify and to show that how much the executives or the seniors are getting and what exactly is the pay system and programs. In many countries, the top manager’s pay is not even disclosed to the shareholders and there are no controls where the full details of the compensation scheme are basically required in order to be disclosed. This basically indicates that, the assessment processes in order to set the executive pay are not even known as transparent in the first place. However there are some other main issues and problems too with regards to the new SEC rules. The amended and the new disclosure rules do not even give the guarantee in the complete disclosure. (Foulkes, 1991) This also suggests that there is a lack of accountability in both the financial institutions and also in the management levels. It also appears that, the executive compensation scheme or also known as ECS in the banking sector are basically being designed by the excessive short termism which not even works in the shareholder’s long term wellbeing and also not supports the prudent risk management. Furthermore, the firms, government and also the regulators have given their executives broadly too much freedom that they can enjoy every single facility which they want and can live in whatever style they want, here the only main thing is the work. These executive should provide quality work so that they can enjoy these kinds of luxury and comfort. It is also proved that executive compensation scheme or also known as ECS is an important mechanism in order to reduce the agency problems and also the costs. However, even with the rigorous market research and also with the consensus, it is still very much difficult in order to define what exactly is the fair compensation in the banking industry, particularly also in a hostile economic environment. Yet, there should be no other justification for the high compensation in the poor performance as seen in the banking sector or in the banking industry. Shareholders also rely on the boards in order to adopt the policies that basically maximize the value of their own shares. However, on the other hand the executives seem to deviate from this main objective and they are engage in other different kind of activities that basically increases their own well-being. This actually indicates that the excessive compensation which is being imposed on today’s executives in order to motivate them have done more harm than doing any good thing. Therefore there should be some more developed and enhanced rules and regulations which can work a lot and can generate better results. Here the main aim is for the managers and also for the executives. They should work hard in order to generate better and better results and they should also try hard in order to make there own executive compensation scheme totally different and unique. With the help of all these efforts the results will be good and will be more advanced. Use investment banks as an example to reason whether ECS is inherently flawed as well as disclosure requirements We basically examine the strategies which are related to the compensation of the commercial bank holding companies over the long time period in order to assess the main and an important impact of some fundamental changes in the banking based business activities. In particular, we also seek to determine whether the CEO compensation is more closely and adequately tied to the presence of the growth options and also to the risk. There is basically noticed an empirical relationship between the chief executive officer (CEO) compensation also known as the investment opportunity set and between the corporate governance mechanisms. Executive compensation schemes are being inherently flawed as well as disclosure requirements because the banking sector basically provides the details and tell us that how the compensation schemes and the programs are not being followed properly and in the result many people are suffering. (Foulkes, 1991) As one of the main economic downturn, liquidity crisis, and also other related asset repricing which continues in order to impact the global financial services industry, it is now increasingly clear that these kind of events will not only be prolonged but they will also leave the industry when they will be transformed. This transformation is basically being driven by many different factors. For instance, the response of each and every single institution to the crisis is now changing the competitive environment and also the competitive market. While some other different institutions are necessarily taking different steps in order to simply survive the crisis, while others are viewing it as a great opportunity to grow, by acquiring the businesses, by picking up the displaced talent, and also by securing the customers who are fleeing troubled institutions. Some institutions especially banks are even using this kind of period of disruption in order to create the competitive advantage through the structural change, by consolidating the support centers, by realigning the workforce, and also by updating the systems during this main and important reorganization. Another transformative driver is the increased government level of the involvement in the financial services industry. While the other public financial support has now created greater stability at some other institutions, there is also the growing pressure in order to change the business practices, such as the executive compensation, the rate of the lending, and also the employment levels. RECOMMENDATION First of all, the compensation arrangement which currently provides the weaker incentives in order to reduce the managerial slack and also to increase the value of the shareholders provide a better way with the help of which an organization can gain maximum benefits. As explained earlier that both the non-equity and also the equity components of the managers’ compensation are basically more decoupled due to the contribution of the manager to the firm performance as compare to the appearances might suggest. Shareholders therefore get the benefit substantially from the improved and also from the better performance that also results in a move towards an optimal contracting arrangement could easily generate. (Bender & Ward, 2008) All the other main and also the prevailing practices not only fail in order to provide the cost-effective incentives and to reduce the slack but also it creates the perverse incentives. For one thing, they also provide managers the incentives in order to change the firm parameters and position in a way that would easily justify the increases in pay. It is also commonly believed that the practice of granting and also of providing the options basically provides the managers with all the incentives not only to undertake the acquisitions that are termed as the value-decreasing for the shareholders but also to make it more and more possible. Furthermore, the managers broad freedom to an unload equity incentives can also produce and can also provide the substantial inefficiencies. Executives who also expect to unload their own shares or the options have a slightly weaker incentive in order to exert the efforts whose payoffs are not going to be well recognized by the market at that time when they basically unwind their own equity positions. Such executives also have the incentives in order to misreport the corporate performance and also to suppress the bad news. Therefore work should be done in a proper way and also in a proper manner by the mutual co operation and consideration. (Falaschetti & Orlando, 2008) CONCLUSION There are many other good theoretical and also different empirical reasons in order to conclude that the managerial power particularly affects the design of an executive compensation in most of the companies or organizations which are being marked by a separation of the ownership and also by the control. Executive compensation can thus be fruitfully and easily analyzed not only as an important instrument for addressing the agency problem which are basically arising from the separation of the ownership and control but also as a main part of the agency problem itself. Agency problems should be well considered and should be well addressed in order to make the firm or the organization the best one so that it can generate best results and can also generate huge profits. The agency theory is the theory which has an immense importance on the banking as well as on the financial sectors. All the problems should be resolved in order to generate best possible results and also to generate the best income in the future. If all the problems will be resolved then only the executive compensation schemes will work better and the managers, superiors or the seniors and the executives will get more and more results in the form of incentives. The executive compensation schemes are no doubt different from all the other schemes because in order to make these kind of programs people actually work hard in order to make the organization the best one and also work hard in order to generate best results so that they can very easily acquire what ever they want. Work should be done in a proper manner in a sequence so that people can also make sure that work is being done in s proper manner and also in an adequate way. Executive compensation schemes also provides other incentives and benefits too which will really helps a lot in order to gain better and better benefits and with the help of this a company can work well, can produce well and in the end will be the best one. If the schemes are being made in a proper manner then only the results will be in a proper manner and also will be in a proper way otherwise one has to suffer a lot and in order to be at the safer side work well and generate well. (Jensen & Murphy, 1998) REFERENCES Patrick Bolton, Mathias Dewatripont, (2005), Contract theory, MIT Press. Fred K. Foulkes, (1991), Executive compensation: a strategic guide for the 1990s, Harvard Business Press. Ruth Bender, Keith Ward, (2008), Corporate Financial Strategy, Butterworth-Heinemann. Dino Falaschetti, Michael Orlando, (2008), Money, financial intermediation and governance, Edward Elgar Publishing. G, P. Jensen, M, C. Murphy, (1998). Compensation and Incentives: practice VS. Theory, McGraw Hill. Bebchuk, L. Fried, J., (2004). Executive Compensation as an agency Problem, Oxford University press. Bloom, M., (1999). The performance effects of pay dispersion on individuals and  organizations. Read More