EXECUTIVE PAY SYSTEM
Benefits and Compensation
Executive compensation is remuneration package paid to executives or top-level management such as chief executive officers (CEO) in a business corporation. “The five components of an executive compensation package are the base salary, long-term/capital appreciation and short-term incentives/bonuses, employee benefits, and perquisites.” (Compensation, 2017) pg. 505. According to the Prudential Company on executive compensation, “it is an important component of these overall human resources policies. Equally important, we view compensation practices as a means for communicating our goals and standards of conduct and performance and for motivating and rewarding employees in relation to their achievements.” (Prudential, 2018).
We will be examining how to design a compensation program, executive compensation package, principle and process for setting executive compensation, executive compensation disclosure rules and executive compensation fairness.
Hrcouncil.ca noted that when determining what to pay employees, it important to consider individual skills and experience in relation to job evaluation and classification. A business philosophy defines “why you are doing things the way you are doing them.” (Leonard, 2108). In compensation packages, business philosophy is developed to design and guide how the company “identify goals and objectives, consider competitiveness in attracting and retaining employees, emphasis on internal and/or external equity, and whether performance is tied to increases.” (Hrcouncil, 2013). A consistent philosophy provides a strong foundation for both the organization and the employee. Communicating, such as in booklets, meetings newsletters, feedback sessions and memos, the compensation plan with employee make them more aware of the plan and the value they give to the company which results “greater motivation and retention”. (hrcouncil.ca, 2013) and allows interaction so individuals questions and concerns can be addressed immediately. Furthermore, communicating compensation package it shows a level of transparency within the company. “A compensation plan can also be used to attract prospective employees and therefore effective external communication is also important.” (hrcouncil.ca, 2013).
The executive pay packages must be consistent with the compensation philosophy of the organization. They must be competitive in terms of what is being offered to similar officers within the same industry and in comparably sized organizations. Concurrently, “the executive pay plan needs to have clearly understood corporate-wide measurements to maximize the compensation investment being made. It is critical to get this pay right for the good of your executives, as well as the health and leadership of the organization.” (Dance, 2011).
According to Garner, executive compensation package components are base salary, incentive pay, with a short-term focus, usually in the form of a bonus, incentive pay, with a long-term focus, usually in some combination of stock awards, option awards, non-equity incentive plan compensation. Garner briefly provide an explanation of each component below:
Below are the five components of an executive compensation package.
1. Base pay
“When considering base pay one should look at what your company can truly afford and market value of the person’s talent. Many companies include an annual cost-of-living adjustment as part of their base pay offer.” (Garner, 2013).
“Tailor the benefits section of your executive compensation packages to meet the needs of those you’re hiring.” (Garner, 2013). For example, someone with a large family might prefer a robust health/dental/life insurance plan over extra vacation time. Be open and flexible in structuring this area.
3. Short-term incentive compensation
This might be in the form of stock options or cash; in most executive compensation packages, it is linked to some short-term, measurable objective that can be attained within a one-year time frame.
4. Long-term incentive compensation
“This is the most important part of executive compensation packages for most executives. Top executives look for a long-term compensation package that is generous and provides them with a powerful incentive to put in the long hours needed to make the company successful so they ultimately earn that long-term reward.” (Garner, 2013).
5. Executive perks
“You have to be a little careful with this category, given the media’s recent scrutiny over executive “sweeteners”. However, these special incentives can be the difference-maker for an executive who’s being pursued by multiple companies such as premium country club membership, access to the company plane, or a Paris apartment.” (Garner, 2013).
“Widespread criticism of CEO pay packages have spurred directors to engage in a diligent search for best practices. This vigilance is transforming the process of executive compensation design, administration and oversight at many major public companies.” (Hodak, 2006).
Hodak noted “The Entrepreneurial Model is a plan that provides legendary wealth for both managers and shareholders. It’s straightforward. Management gets a fixed share of the profits generated by the business or a fixed percentage of the value of the business.” (Hodak, 2006). Which is consistent with an entrepreneurial model, the most effective plans appear to be profit-based, objective and stable-often with some subjective element in the distribution, if not the funding, of bonuses. For example, “in 1965, Nucor’s then president Ken Iverson instituted a plan that funded a bonus pool based on a share of the profits above a threshold level of profitability.” (Hodak, 2006).
The plan’s integrity came from three sources: “First, a discipline for setting the threshold profit, which was based on capital invested and past performance, provided accountability for new capital, and ensured that management rarely got paid twice for the same profit achievement. Second, Nucor had one plan for senior executives, and it paid out in cash and stock. There was no opportunity to make up with a second plan what they failed to achieve in the first. Third, and perhaps most important, the plan was stable.” (Hodak, 2006). That fixed share of profitability was there whenever the profits materialized, whether it took one year or 10.
This plan survived for 37 years. As far as Nucor’s managers were concerned, it motivated and rewarded long-term performance. After several years with flat profits, Nucor’s plan paid out handsomely after management took a struggling joist company and turned it into a highly profitable steelmaker. In its fairness, simplicity and integrity, it may be the most successful incentive plan ever created. The integrity of the plan rewards the integrity of management.
A key to building a great business is acting with integrity. Integrity means doing the right thing in all situations at all times. Martin Luther King Jr. taught that “The time is always right to do what is right.” Proverbs 4 25-27 states, “Let your eyes look straight ahead; fix your gaze directly before you. Give careful thought to the paths for your feet and be steadfast in all your ways. Do not turn to the right or the left; keep your foot from evil.”
The key players in setting executive compensation are the boards of directors, compensation committees, consultants, shareholders and human resources.
According to Brossy consulting group, the board of directors representatives is elected by shareholders, to ensure that executive compensation programs support the creation and sustainability of shareholder and attract and retain of executive talent to performance-based compensation. Second, executive’s compensation consultants seek to be compensated for their individual performance and contribution to the success of an organization. Third, shareholders seek reasonable alignment of executive compensation with shareholder returns and sustainable company performance. Finally, human resources is responsible for the design and administration of executive compensation programs. The Human Resources function typically acts as the liaison between management and the Board of Directors on issues of executive compensation. (Brossy, 2018).
Three alternative theories explain the principles and processes for setting executive compensation: agency theory, tournament theory and social comparison theory.
“Agency theory is concerned with resolving problems between shareholders and company executives that can exist in agency relationships due to unaligned goals or different aversion levels to risk. The most common agency relationship in business occurs between shareholders (principal) and company executives (agents).” (Investopedia, 2018).
“Under agency theory, shareholders delegate control to top executives to represent their ownership interest.” (Martocchio, 2004) pg.421. The main shareholder objective is to protect the company’s competitive interests. Shareholders use compensation to align executives’ interest with shareholders. “Tournament theory cast lucrative executive compensation as the prize in a series of tournaments or contest among middle-and top level managers who aspire to become CEO.” (Martocchio, 2004) pg.423. Social comparison theory, individuals need to evaluate their accomplishments, and they do so comparing themselves to similar individuals. (Martocchio, 2004) pg.423.
Find the right and best talent. When your people get better, your company will get better. Release the passion of your people and you find passionate people. A principle that has shaped many businesses and business leaders is 2 Timothy 2:2 New International Version. People can either make or break a business. Finding the right kind of people to add to an organization is essential to the success of the organization. Paul gives some fantastic wisdom to his young mentee when he states “And the things you have heard me say in the presence of many witnesses entrust to reliable people who will also be qualified to teach others.”
The Securities and Exchange Commission (SEC) is a non-partisan, quasijudical federal government agency with the responsibility for administering federal securities laws.” (Martocchio, 2004) pg. 424. Addition, the Securities and Exchange Commission include the executive pay practices According to the SEC, “The federal securities laws require clear, concise and understandable disclosure about compensation paid to CEOs, CFOs and certain other high-ranking executive officers of public companies.” (SEC, 2014). Many types of documents that a company files with the SEC include information about the company’s executive compensation policies and practices. (SEC, 2014). The easiest place to look up information on executive pay is the annual proxy statement.
Moreover, the SEC provides the summary compensation table which is a detailed overview of compensation information on companies Chief Executive Officer and Chief Financial Officer and it is the cornerstone of the SEC’s required disclosure on executive pay practices and compensation. (SEC, 2014).
Named Executive Officers Compensation Alaska Air Group 2017 Interactive Proxy Statement
Summary Compensation Table: Alaska Air Group. Source: https://iiwisdom.com/alk-17/executive-compensation/
Practice the Golden Rule. Think of others first. Treat others like you want to be treated. Practice thoughtfulness. When you think of the customers, they will think of you. Luke 6:31 states, “Do to others as you would have them do to you.” Many great business use this principle as the foundation for their business. J.C. Penney used just this principle to start and grow his business into a thriving corporation. He once was quoted as having said, “I cannot remember a time when the Golden Rule was not my motto and precept, the torch that guided my footsteps.”
Are U.S. executives paid too much? Many people think so such as employees, public and the news outlets generally suggest that executives are overpaid. One should form own opinion based on the following pertinent information: “comparison between executive compensation and other worker groups, strategic questions: is pay for performance, executive compensation fairness and international competitiveness.” (Martocchio, 2004). pg. 427-428.
Samuelson and Stout quoted, the Aspen Group “to get executive compensation back on track, it is essential to focus on three strategies: designing new corporate performance metrics, changing the nature of investor communications, and reforming compensation structures.” (Samuelson & Stout, 2009).
First of all, in designing a new corporate performance metrics companies need to measure long-run corporate performance, rather than simply relying on stock price. Also, in investor communications companies need to ensure corporate officers and directors communicate with shareholders not about next quarter’s expected profits, but about next year’s and even next decade’s.
Lastly and most importantly, reforming compensation structures, companies must change the way they reward not only CEOs and midlevel executives, but also institutional portfolio managers at hedge funds, mutual funds, and pension funds. Executives and managers should be rewarded for the actions and decisions within their control, not general market movements. Incentive-based pay should be based on long-term metrics, not one year’s profits. (Samuelson & Stout, 2009).
In the above graph, one can see the difference between a CEO pay and a full-time worker is starling. According to a new report on CEO pay from the Economic Policy Institute, chief executives at those 350 companies made $15.6 million on average in 2016—271 times what the typical worker earns. (Donnelly, 2017).
Furthermore, according to AFL-CIO analysis conducted in 2017, CEOs of S&P 500 Index companies received, on average, $13.94 million in total compensation. America’s production and nonsupervisory workers earned only $38,613, on average, in 2017—a CEO-to-worker pay ratio of 361 to 1. (AFL-CIO, 2018).
Mullaney noted that CEO pay is not tightly tied to performance at all, according to a much-cited 2000 study in the Journal of Management. “It found that variations in company performance account for only about 5 percent of the variation between how much companies pay their top executives. Last year, the CEO compensation growth of 9.1 percent trailed the S&P 500’s 13.4 percent total return.” (Mullaney, 2015).
Micewski and Troy analyzed multiple ethical issues with executive compensation using the deontological approach. “Deontology concerns the moral duties that apply to us. Accordingly, there are acts we are obligated to perform or to refrain from performing to (McNaughton and Rawling 1998, 2011) comply with such duties. Thus, business activity should be pursued within self-imposed moral boundaries.” (Micewski and Troy 2007).
According to the deontological theory, the principle of fiduciary duty is a moral principle that we are obliged to follow and examine the ethics of compensation using this principle. “The principle-agent relationship, which is central to executive compensation, generates fiduciary duties for executives and directors to shareholders.” (James-Balnaves, 2015).
It’s not easy being a chief executive, even if you’re Mr. Burns. But what is “fair” compensation for people holding the job? (Fox)
There are many degrees of opinion if executives are paid too much. One can look at the differences in CEO and the average worker, CEO pay tied to company performance, is CEO pay fair and global competitiveness to see why many people are concern with the situation of executive compensation. Whether you agree or disagree it important for companies to make investments in the right places. Invest wisely. Don’t forget to invest in yourself. Make the right investments to help the business to grow. Invest in your people. Invest wisely and you will see a great return on your investments. Matthew 6:21 New International Version states, “For where your treasure is, there your heart will be also.” Investment is another term for treasure. Leaders are called to lead with passion or all of their heart. Therefore a leader must make investments wisely. Leaders in businesses are called upon to make many investments. A leader must make use of the resources of the company to make the right investments in the business, people, and infrastructure. When businesses are invested in wisely, the business will grow. Good investments set the direction and the path of a business to ensure its growth and development. When a business is neglected, it is doomed to shrink and die.
In the above chart, it shows CEO pay data in advanced economies. According to McDonnell, U.S. CEOs earn from 400 to 500 times the median salary for workers. For CEOs in the U.K., the ratio is 22; in France, its 15; and in Germany, it’s 12. In an effect to restrain increasing CEO, “in some countries, a “say-for-pay” policy allows shareholders non-binding votes to approve or reject a CEO’s compensation package.” (McDonnell, 2018). For example, the European Union has proposed a binding vote on CEO pay for public companies. France capped the ratio between CEO pay and the wages of the lowest-paid workers, and Germany placed a cap on CEO salaries. CEO pay is rapidly rising in emerging economies such as China, India and countries in the Middle East. Executive salaries in Asia exceeded those in Europe for the first time in 2011 and executive pay in the Middle East is expected to be at European levels in 2013.
We will be examining how to design a compensation program, executive compensation package, principle and process for setting executive compensation, executive compensation disclosure rules and executive compensation fairness. Executive compensation is a collective term for all the components that make up the remuneration package of chief executive officers and top level managers in a business corporation. The components are a base salary, long-term and short-term incentives/bonuses, shares and options, employee benefits, and perquisites. The basic salary is a definite component, while the other components may vary depending upon company policies and performance.
AFL-CIO. (2018). “Executive Paywatch” Retrieved from https://aflcio.org/paywatch
McDonnell, Steve. “CEO Compensation in the US vs. the World.” Retrieved from http://work.chron.com/ceo-compensation-vs-world-15509.html.
Dance, Beverly, 2011 February 28. “The Basics of Executive Compensation” Retrieved from https://www.payscale.com/compensation-today/2011/02/executive-compensation
Donnelly, Grace, 2017 July 20. “Top CEOs Make More in Two Days than an Average Employee Does in One Year” Retrieved from http://fortune.com/2017/07/20/ceo-pay-ratio-2016/
Ginni Garner, 2013 June 12. “The 5 Most Important Elements of Executive Compensation Packages” Retrieved from http://www.thegarnergrp.com/blog/bid/94565/The-5-Most-Important-Elements-of-Executive-Compensation-Packages
Hodak, Marc 2006 August 16 “Pay for Performance: Beating “Best Practices” Retrieved from https://chiefexecutive.net/pay-for-performance-beating-best-practices/
Hrcouncil.ca (2013). “Compensation ; Benefits” http://hrcouncil.ca/hr-toolkit/compensation-wages.cfm
Investopedia (2018). “Agency Theory” Retrieved from https://www.investopedia.com/terms/a/agencytheory.asp
James-Balnaves, Aidan, 2015 June 15. “The Ethics of Executive Compensation: A Matter of Duty” Retrieved from http://sevenpillarsinstitute.org/the-ethics-of-executive-compensation-a-matter-of-duty/
Martocchio, Joseph J. (2004). “Strategic Compensation: A Human Resource Management Approach”. 3rd Ed. Upper Saddle River, New Jersey. Pearson Education, Inc.
Mullaney, Tim, 2015 May 19. “Why corporate CEO pay is so high, and going higher “Retrieved from https://www.cnbc.com/2015/05/18/why-corporate-ceo-pay-is-so-high-and-going-higher.html
Newman Jerry M., Gerhart Barry, Milkovich George T. (2017). “Compensation”. 12th Ed. New York, NY. McGraw-Hill Education
Prudential Financial (2018). “Proxy Statement” Retrieved from https://www.prudential.com/links/about/executive-compensation
Samuelson, Judith F. and Stout, Lynn A., 2009 February 26 “Are Executives Paid Too Much?” Retrieved from https://www.wsj.com/articles/SB123561746955678771
Securities and Exchange Commission, 2014 October 21. “Executive Compensation” Retrieved from https://www.sec.gov/fast-answers/answers-execomphtm.html
Semler Brossy Consulting Group LLC (2018). “A Career in Executive Compensation Key Players” Retrieved from http://www.semlerbrossy.com/careers/who-are-the-stakeholders/