Executive compensation Executive compensation is how top execut- ives of business corporations are paid. This includes a basic salary, bonuses, shares, op- tions and other company benefits. Over the past three decades, executive compensation has risen dramatically beyond the rising levels of an average worker’s wage.[1] Types of compensation See also: Employee stock option, Golden parachute, and Performance-related pay There are five basic tools to compensation or remuneration. • a base salary • short-term incentives, or bonuses • long-term incentive plans (LTIP) • employee benefits • perquisites, or perks In a typical modern US corporation, the CEO and other top executives are paid salary plus short-term incentives or bonuses. This com- bination is referred to as Total Cash Com- pensation (TCC). Short-term incentives usu- ally are formula-driven and have some per- formance criteria attached depending on the role of the executive. For example, the Sales Director’s performance related bonus may be based on incremental revenue growth turnover; a CEO’s could be based on incre- mental profitability and revenue growth. Bo- nuses are after-the-fact (not formula driven) and often discretionary. Executives may also be compensated with a mixture of cash and shares of the company which are almost al- ways subject to vesting restrictions (a long- term incentive). To be considered a long-term incentive the measurement period must be in excess of one year (3-5 years is common). The vesting term refers to the period of time before the recipient has the right to transfer shares and realize value. Vesting can be based on time, performance or both. For ex- ample a CEO might get 1 million in cash, and 1 million in company shares (and share buy options used). Other components of an exec- utive compensation package may include such perks as generous retirement plans, health insurance, a chauffered limousine, an executive jet[2], interest free loans for the purchase of housing, etc. Stock options Supporters of stock options say they align the interests of CEOs to those of shareholders, since options are valuable only if the stock price remains above the option’s strike price. Stock options are now counted as a corporate expense (non-cash), which impacts a com- pany’s income statement and makes the dis- tribution of options more transparent to shareholders. Critics of stock options charge that they are granted excessively and that they invite management abuses such as the options backdating of such grants. Stock op- tions also pose a conflict of interest in which a CEO can artificially raise the stock price to cash in stock options at the expense of the company’s long-term health, although this is a problem for any type of incentive compens- ation that goes unmonitored by directors. Indeed, "reload" stock options allow execut- ives to exercise options and then replace them in part (and sometimes in whole), es- sentially selling the company stock short (i.e., profiting from the stock’s decline). For vari- ous reasons, including the accounting charge, concerns about dilution and negative publicity related to stock options, companies have reduced the size of grants to executives. Restricted stock Executives are also compensated with re- stricted stock, which is stock given to an ex- ecutive that cannot be sold until certain con- ditions are met and has the same value as the market price of the stock at the time of grant. As the size of stock option grants have been reduced, the number of companies granting restricted stock either with stock options or instead of, has increased. Restricted stock has its detractors, too, as it has value even when the stock price falls. As alternative to straight time vested restricted stock, com- panies have been adding performance type features to their grants. These grants, which could be called performance shares, do not vest or are not granted until these conditions From Wikipedia, the free encyclopedia Executive compensation 1 are met. These performance conditions could be earnings per share or internal financial targets. Tax issues Cash compensation is taxable to an individual at a high individual rate. If part of that in- come can be converted to long-term capital gain, for example by granting stock options instead of cash to an executive, a more ad- vantageous tax treatment may be obtained by the executive. Levels of compensation The levels of compensation in all countries has been rising dramatically over the past decades. Not only is it rising in absolute terms, but also in relative terms. Fortune 500 compensation During 2003, about half of Fortune 500 CEO compensation was in cash pay and bonuses, and the other half in vested restricted stock, and gains from exercised stock options ac- cording to Forbes magazine.[2] Forbes magazine counted the 500 CEOs compensa- tion to $3.3 billion during 2003 (which makes $6.6 million a piece). Notice that this figure includes gains from stock call options used; the options may have been rewarded many years before the option to buy is used. Forbes categories of compensation The categories that Forbes use are (1) salary (cash), (2) bonus (cash), (3) other (market value of restricted stock received), and (4) stock gains from option exercise (the gains being the difference between the price paid for the stock when the option was exercised and that days market price of the stock). If you see someone "making" $100 million or $200 million during the year, chances are 90% of that is coming from options (earned during many years) being exercised. Typical compensation The typical salary in the top of the list is $1 million - $3 million.[3] The typical top cash bonus is $10 million - $15 million.[4] The highest stock bonus is $20 million.[5] The highest option exercise have been in the range of $100 million - $200 million [6]. Regulation There are a number of strategies that could be employed as a response to the growth of executive compensation. • In the United States, shareholders must approve all equity compensation plans. Shareholders can simply vote against the issuance of any equity plans. This would eliminate huge windfalls that can be due to a rising stock market or years of retained earnings. • Independent non-executive director setting of compensation is widely practised. Remuneration is the archetype of self dealing. An independent remuneration committee is an attempt to have pay packages set at arms’ length from the directors who are getting paid. • Disclosure of salaries is the first step, so that company stakeholders can know and decide whether or not they think remuneration is fair. In the UK, the Directors’ Remuneration Report Regulations 2002[7] introduced a requirement into the old Companies Act 1985, the requirement to release all details of pay in the annual accounts. This is now codified in the Companies Act 2006. Similar requirements exist in most countries, including the U.S., Germany, and Canada. • A say on pay - a non-binding vote of the general meeting to approve director pay packages, is practised in a growing number of countries. Some commentators have advocated a mandatory binding vote for large amounts (e.g. over $5 million).[8] The aim is that the vote will be a highly influential signal to a board to not raise salaries beyond reasonable levels. The general meeting means shareholders in most countries. In most European countries though, with two-tier board structures, a supervisory board will represent employees and shareholders alike. It is this supervisory board which votes on executive compensation. • Progressive taxation is a more general strategy that affects executive compensation, as well as other highly paid people. There has been a recent trend to cutting the highest bracket tax payers, a notable example being the tax cuts in the U.S. Ex-Soviet Baltic States also have a flat tax system for incomes. Executive From Wikipedia, the free encyclopedia Executive compensation 2 compensation could be checked by taxing more heavily the highest earners, for instance by taking a greater percentage of income over $200,000. • Maximum wage is an idea which has not been implemented anywhere. The argument is to place a cap on the amount that any person may legally make, in the same way as there is a floor of a minimum wage so that people can not earn too little. • Indexing Operating Performance is a way to make bonus targets business cycle independent. Indexed bonus targets move with the business cycle and are therefore fairer and valid for a longer period of time. Criticism Many newspaper stories[9] show people ex- pressing concern that CEOs are paid too much for the services they provide. In Searching for a Corporate Savior: The Irra- tional Quest for Charismatic CEOs, Harvard Business School professor Rakesh Khurana documents the problem of excessive CEO compensation, showing that the return on in- vestment from these pay packages is very poor compared to other outlays of corporate resources. Defenders of high executive pay say that the global war for talent and the rise of private equity firms can explain much of the increase in executive pay. For example, while in conservative Japan a senior executive has few alternatives to his current employer, in the United States it is acceptable and even admirable for a senior executive to jump to a competitor, to a private equity firm, or to a private equity portfolio company. Portfolio company executives take a pay cut but are routinely granted stock options for ownership of ten percent of the portfolio company, con- tingent on a successful tenure. Rather than signaling a conspiracy, defenders argue, the increase in executive pay is a mere byproduct of supply and demand for executive talent. However, U.S. executives make substantially more than their European and Asian counter- parts.[9] Shareholders, often members of the Coun- cil of Institutional Investors or the Interfaith Center on Corporate Responsibility have of- ten filed shareholder resolutions in protest. 21 such resolutions were filed in 2003. [10] About a dozen were voted on in 2007, with two coming very close to passing (at Verizon, a recount is currently going on).[11] The U.S. Congress is currently debating mandating shareholder approval of executive pay pack- ages at publicly traded U.S. companies. [12] The U.S. stood first in the world in 2005 with a ratio of 39:1 CEO’s compensation to pay of manufacturing production workers. Britain second with 31.8:1; Italy third with 25.9:1, New Zealand fourth with 24.9:1.[13] United States The U.S. Securities and Exchange Commis- sion has asked publicly traded companies to disclose more information explaining how their executives’ compensation amounts are determined. The SEC has also posted com- pensation amounts on its website[14] to make it easier for investors to compare compensa- tion amounts paid by different companies. It is interesting to juxtapose SEC regulations related to executive compensation with Con- gressional efforts to address such compensa- tion. [15] In 2005, the issue of executive compensa- tion at American companies has been harshly criticized by columnist and Pulitzer Prize winner Gretchen Morgenson in her Market Watch column for the Sunday "Money & Business" section of the New York Times newspaper. Unions have been very vocal in their op- position to high executive compensation. The AFL-CIO sponsors a website called Executive Paywatch [3] [16] which allows users to com- pare their salaries to the CEOs of the com- panies where they work. In 2007, CEOs in the S&P 500, averaged $10.5 million annually, 344 times the pay of typical American workers. This was a drop in ratio from 2000, when they averaged 525 times the average pay.[17] Australia In Australia, shareholders can vote against the pay rises of board members, but the vote is non-binding.[18] Instead the shareholders can sack some or all of the board members. [19] See also • Agency cost • Bonus-Malus • Golden handshake • Golden parachute From Wikipedia, the free encyclopedia Executive compensation 3 • Options backdating • Remuneration Notes [1] see, for one example, The Guardian, August 4, 2005, "US executive pay goes off the scale" [2] [1] [3] see, Immelt [4] see,(Henry R. Silverman [5] see,(Fuld) [6] see,(Reuben Mark) [7] SI 2002/1986 [8] Failing Banks’ Executive Pay May Face New Rules [9] ^ "Letter From Washington: As U.S. rich-poor gap grows, so does public outcry". Bloomberg News. International Herald Tribune. http://www.iht.com/ articles/2007/02/18/news/letter.php. Retrieved on 2007-02-18. [10]USA Today May 19, 2003 [11]New York Times, May 4 2007, Verizon Vote On Pay Levels To Be Decided In a Recount [12]Shareholders one step closer to say on pay, Socialfunds.com May 3 2007 [13] ’ Landy, Heather, Behind the Big Paydays, The Washington Post, November 15, 2008 [14]The Securities and Exchange Commission website [15]Kenneth Rosen, Who Killed Katie Couric? And Other Tales from the World of Executive Compensation Reform, 76 Fordham Law Review 2907 (2007) [16]Forbes.com Best Of The Web [17] ’ Landy, Heather, Behind the Big Paydays, The Washington Post, November 15, 2008 [18]The Age article on dealing with board members [19]The Age article on executive pay References • Sean O’Grady, ’Economist Stiglitz blames crunch on ’flawed’ City bonuses system’ (24.3.2008) The Independent External links • 2008 Executive Compensation, The Globe Opinion • CEO Compensation from Equilar • Forbes.com - Executive Pay (updated with 2004 pay) • Executive Remuneration - Analytical article by Mercer/CEO Forum Group • The Guardian, August 4, 2005, "Chief executives’ pay rises to £2.5m average" in United Kingdom • Executive Compensation: The Fallacy of Disclosure Paper by Paolo Cioppa, UC Berkeley, Boalt Hall School of Law • European Executive Compensation Data Visualizer 2006 2007 Retrieved from "http://en.wikipedia.org/wiki/Executive_compensation" Categories: Management, Organizational studies and human resource management, Employ- ment compensation, Recruitment This page was last modified on 14 May 2009, at 14:46 (UTC). 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