Executive Compensation is a broad termfor the financial compensation awarded to a firm’s executives. ExecutiveCompensation packages are designed by a company’s Board of Directors, typicallyby the Compensation Committee consisting of independent directors, with thepurpose of incentivizing the executive team, who have a significant impact oncompany strategy, decision-making, and value creation (Pay for Performance) aswell as enhancing Executive Retention. Corporate executives have been receivingimmense compensation packages specifically in the form of stock options. Thepurpose of the incentives is to align the goals of executives and stakeholders.Although theory encourages desirable behaviour, many a time executives takeadvantage of their governing position and engage in fraudulent activity toincrease personal wealth at the expense of the corporations’ shareholders. Organizations approach decisions aboutexecutive compensation in their own ways, and the way an organization does sodepends on its circumstances, what it can afford, and the values and beliefsthat drive its decisions about executive pay.
Trustees and CEOs make decisionsthey think are best for their organizations. 2.0 FACTORSCONTRIBUTING TO EXECUTIVE COMPENSATION2.1 Hiring The Best The intentions begin with the board’s decision to hireexceptionally talented, highly experienced executives and continue with the board’swillingness to pay the salary required to hire and retain them. Externalrecruiting tends to drive pay up. When organizations recruit seasonedexecutives from other, similarly sized organizations, they generally need to paywell above average, more than they would need to pay to promote an internalcandidate.
2.2 Retention FactorThe intent to pay competitively drives up salary evenfor internally promoted executives and incumbents, however. Organizations whosepolicy is to pay at median increase pay faster than the rate of inflation forany executive paid less than median, and organizations whose policy is to payat the 75th percentile continuously increase executives’ pay to stay ahead ofthe pack.
2.3 Performance FactorThe intent to pay above average in expectation ofabove-average performance drives up pay for all executives, whether or not they.Standard salary administration practices call for bringing salaries up to theintended level within a few years, as long as the incumbent performs reasonablywell. Furthermore, incentive plans tend to reward institutional performancemore than individual performance, so even average performers end up being paidabove average.3.0 CHARACTERISTICS OF EXECUTIVECOMPENSATION3.
1 Pay Packages Executive pay packages differ substantially fromtypical salaried or hourly employee compensation because unlike typicalemployee pay, the vast majority of an executive’s pay is contingentcompensation and structured only to reward the executive for actual, positivecompany performance and growth in shareholder value. To this end, executivecompensation packages typically utilize six distinct compensation componentsincludes base Salary, Short-Term Incentive, Long-Term Incentive, Employee Benefits,Perquisites and Severance/Change-in-Control Payments. A company’s CompensationCommittee will structure their executive’s pay packages utilizing a combinationof the above components to help achieve the company’s Pay for Performanceand/or Retention objectives.3.
2 VestingA core attribute of most EquityCompensation is the concept of vesting, which conditions the full ownership ofthe equity awards on the employee’s compliance with certain covenants. Thevesting terms reinforce the incentive objective of equity awards by promotingretention while providing the employee with a disincentive to engage in certaindetrimental behaviors during a set time period. These covenants typically comein two forms.
The first form requires an employee to retain all or a portion ofawarded shares until the employee reaches prescribed levels of stock ownership(ownership guidelines), reinforcing the link to shareholders. The secondcovenant requires a forfeiture of the shares if the employee elects to engagein certain detrimental behaviors during a specified period of time. (Perel,2003). The most common of these are the conditionson restricted stock, which require employees to remain employed with thecompany for a certain period of time after the shares are awarded, but beforethe shares vest and provide full ownership. If an employee voluntarily leavesthe company during the restriction period to work elsewhere, typically, theemployee forfeits the opportunity to obtain full ownership of the shares. Theresult is different for an employee who retires from a company and continues tohonor the covenants during the vesting period.
In retirement, the company may proratethe vesting of unvested shares based on the amount of time since the award wasgranted or allow all outstanding restricted stock to continue to vest inretirement, giving the retiring employee greater ownership after the restrictedperiod. (Bebchuk & Fried, 2003).