Concepts that Pertain to CEO Compensation (Research Paper Sample)

Fair CEO Compensation
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Fair CEO Compensation
Introduction
Executive officers oversee the day-to-day management of a business or firm. Just as other employees, they need financial compensation for their work. The level and structure of compensation should be sufficient to attract, retain, and motivate skilled executives to create stakeholder and shareholder value (Chan et al., 2012). The right size and structure of compensation packages allow qualified executives to continue giving their services to the firm for its benefit. Compensation elements include equity-based pay and annual bonuses. It is essential to evaluate the associations between compensation, performance, and risk for fair CEO compensation.
Summary of the Topic
The process of compensation encompasses various components as follows. First, the board of directors forming the compensation committee gives recommendations on the size and structure of recommendations for the CEO and other senior executives. Typically, they come up with these recommendations in liaison with the finance and human resource departments along with third-party consultants (Chan et al., 2012). Independent directors who are part of an entire board of directors give a vote that approves the compensation packages. In addition, equity-based compensation plans like restricted stock awards and stock option plans are generally approved by a vote of shareholders.
There are various details included in a compensation plan, including that requiring shareholder approval and vice versa. One of these critical details is the fair value of the total compensation that the CEO is awarded in each of the prior three years and the value realized through vesting of equity grants (Larcker & Tayan, 2016). The CD &A is a vital detail of compensation that guides shareholders in assessing the compensation program. This helpful information includes the philosophy of the organization's compensation, features of the pay package and total warded compensation, peer groups for making comparisons in designing compensation and performance evaluation, pay equity, and much more.
A compensation plan performs three significant purposes. The first purpose is to attract the right individuals with the suitable skill set, behavioral profile, and experience required to thrive in a position. Second, it should be sufficient to retain those qualified individuals, or they will quit the company for another one that offers more suitable compensation for their proficiency. Third, it has to offer the right incentives to motivate these qualified individuals to perform their work well (Carola & Raven, 2010). It includes motivating consistent behaviors with the company strategy and the organization's risk profile, and the discouragement of self-interested conducts. The elements of a compensation package are enormous and include annual salary, annual bonuses, stock options, restricted stock, perquisites, performance shares, benefits, and contractual agreements. However, a compensate
on package may include some or all of the above elements.
A Detailed Discussion of CEO Compensation
Examination of CEO Compensation
Improper compensation of executives leads to lack of incentive to perform exemplary in the best interest of shareholders, which subsequently costs the particular shareholders. Examination of CEO compensation can be a daunting task for the compensation committee and board of directors. Mostly, they need to consider pay versus performance to evaluate CEO compensation. Unfortunately, even when they are faltering, most organizations give raises and bonuses to their executives. The specific metric commonly employed is comparison of change year over year in executive pay raises to the change year in stock price (Larcker & Tayan, 2016). To check if the executive is not overpaid, the change in the stock price should outpace the change in pay. The CEO compensation should be tied to the overall performance of the organization since it is healthy by providing CEOs with the incentive to perform outstandingly. Overcompensation for underperformance is witnessed when CEOs receive a high rate but they do not perform.
While examining CEO compensation, it is important for the compensation committee and the board of directors to consider executive compensation laws. Firstly, enterprises need to understand that a compensation package may be subjected to particular contractual limitations or restrictions. One of those contractual restrictions is the stock ownership guidelines that define the minimum amount of stock a CEO is needed to hold during employment that is usually expressed as a multiple of base salary (Larcker & Tayan, 2016). Pledging restrictions is another limitation that involves using shares as security margin loan through a brokerage account, personal loan, and any other form of financial transaction (David & Brian, 2007). As per the Dodd-Frank Act, companies should disclose activity by directors and officers. The other limitation is clawbacks and deferred payouts that entail a contractual provision that allows an organization to reclaim compensation in the coming years when it becomes apparent that bonus compensation should not have been previously awarded (Chan et al., 2012). The Dodd-Frank Act expanded the utilization of clawbacks by calling for organizations to create, implement, and disclose a clawback policy.
Determining Compensation
The level of compensation that the CEO and other senior executives are paid is determined by the compensation committee and the board of directors. During the determination process, they need to choose a blend of long-term and short-term features to realize a payout structure consistent with the firm's strategy. This exercise should be straightforward, and the total compensation level must be proportionate with the received value of services (David & Brian, 2007). First, the compensation committee and board of directors should determine the value the organization anticipates to create within a logical time prospect, possibly five years. Then, they need to determine the extent of this value attributable to the CEO's efforts (Larcker & Tayan, 2016). Lastly, they should determine the proportion of that value to offer the CEO as compensation. Even as most boards follow this kind of approach, it becomes difficult to gauge the value creation attributable to specific CEO''s efforts.
For this reason, most boards do benchmarking of their CEO's pay against that of other similar companies to determine compensation levels. The benchmarked companies are often called peer groups. Compensation consultants' interviews reveal that companies mainly aim to offer a basic salary and annual bonus compensation or primarily equity-based compensation (Larcker & Tayan, 2016). After benchmarking, the compensation committee is required to ensure the suggested level of pay has the same level of risk as the compensation package put into consideration for the CEO. Benchmarking allows the compensation committee and the board of directors to adjust the compensation levels of the CEO (Shin, 2013). Peer benchmarking guides them to regulate CEO compensation upward.
Even as more and more companies prefer benchmarking to remain competitive concerning the compensation level, the approach has apparent drawbacks as companies increase pay to fit the amount their peers are paying, compensation risks are inflated over time. The median creates a well-recognized ratcheting impact when it tends to increase as multiple companies within the group attempt to achieve or go beyond the median (Crawford et al., 2014). The other drawback of benchmarking is determining pay without apparent consideration to value creation. As a result, CEOs are motivated to get involved in unprofitable conduct like acquiring a competitor to purely expand the size of the general organization leading to a change in the perceived peer group, and thus, the CEO's pay. Benchmarking can result in very diverse pay packages that heavily rely on the organizations that are part of the peer group.
Concepts that Pertain to CEO Compensation
Third-Party Compensation Consultants
Third-party consultants help assist in the process of setting compensation. Opponents argue that consulting firms can cause a conflict of interest to structure the CEO compensation package. Consulting firms can help organizations to design benefit plans or manage pension assets. However, they also have shortcomings, such as the fear of recommending lower pay due to fear of losing contracts for their services to a particular organization (Bizjak et al., 2008). Whereas conflict of interest could be a source of concern, evidence shows that consulting firms providing other services usually do not give room for conflict of interest to impact the determination of the level of executive pay. Organizations are needed to reveal if they are using a compensation consultant, the complete discrimination of services they provide, and the sum payments made.
The Right Measure of Pay
Three basic ways are utilized to gauge executive compensation, including the expected compensation, the earned compensation, and the realized compensation. The expected compensation denotes the anticipated value of compensation that the executive is pledged in a specific year. It includes the total value of the salary, long-term cash plan, yearly bonus, restricted stock awards, and stock option awards in the same year they are settled (Carola & Raven, 2010). Some of these essentials are not dependent on future outcomes like stock price or operating performance, and thus their a...