IT’S NOT FAIR!Executive Compensation

INTRODUCTION TO EXECUTIVE COMPENSATION

• In boom or recession, a company is growing or surviving not by default but by effective strategies .This strategic decisions are taken by CEO.

• The compensation program serves three main purposes.1. It must attract executives with the skills, experiences, and behavioural profile

necessary to succeed in the position.2. It must be sufficient to retain these individuals, so they do not leave for

alternative employment.3. It must motivate them to perform in a manner consistent with the strategy and

risk-profile of the organization and discourage self-interested behaviour.

ELEMENTS OF COMPENSATIONThe compensation package includes some or all of the following:• Annual salary - Fixed cash payment made evenly over the year. • Annual bonus - Additional payment (usually cash) awarded if performance

exceeds predetermined targets. • Stock options - Right to buy shares in the future at a fixed exercise price,

generally equal to stock price on the grant date. • Performance units (shares) - Cash (or stock) granted if specified targets are met

over a three-to five-year period. Size of the award is generally expressed as a percentage of base salary. Performance units are similar to a longer-term version of the annual bonus. Perquisites Other amenities purchased or provided by the company (such as personal use of company airplane).

ELEMENTS OF COMPENSATION• Contractual agreements - Other cash or stock payments stipulated in the

employment agreement, such as severance, post-retirement consulting, and change-in-control payments (“golden parachutes”).

• Benefits - Other benefits such as health insurance, post-retirement health insurance, 401(k), supplemental executive retirement plans (SERPs), life insurance, payment for use of financial planner, and certain tax reimbursements.

FACTS OF CASE STUDY

• How is executive compensation determined by committees?

• Principles of equity theory.

• Comparison with peer groups( other firms of same industry).

• Critics of executive compensation.

• Researcher Cary Cooper.

• Average S&P 500 CEO.

DESIGNING THE COMPENSATION PROGRAM

• The compensation committee recommends compensation of the CEO and other executive officers.

• Packages are approved by independent directors of the full board. Shareholders approve equity-based compensation.

• Most boards benchmark CEO pay against a peer group of companies comparable in size, industry, and/or geography.

• There are potential drawbacks to benchmarking:– Might lead to ratcheting.– Is based on size rather than value creation. – Is highly dependent on companies included in peer group.

Companies include unrelated firms in peer group, and the inclusion of these firms tends to increase pay.

RATIO OF CEO PAY AND AVERAGE EMPLOYEE PAY

• CEO Compensation is 20 times the salary of the lowest-paid employee.• In an average 500 CEOs are paid 263 times what the lowest paid labourers

makes.• It is 8 times more than the ratio from the 1950s.• Results are based on:

-industry , size, location and workforce composition-expected vs. realisation-mean vs. median calculations

Q 1. How does the executive compensation issue relate to equity theory? Who do you think should be the comparative others in these equity judgments? How should we determine what is a “fair” level of pay for top executives?

• With the ratio being “eight times higher than the same ratio from the 1950s,” CEOs are being ridiculed for being overpaid in comparison with the rest of the company.

• If executive compensation can be more closely tied in with the total revenue of the company for the year and be more evenly distributed amongst employees, moral and work efforts should see an increase.

• Although the CEO is the head of the business, typically the CEO is not the one putting in all of the work, that’s why a company cannot run off of a single employee.

Q 2. Can you think of procedural justice implications related to the ways pay policies for top executives have been instituted? Do these pay-making decisions follow the procedural justice principles outlined in the chapter?

• The most obvious procedural justice implication used to calculate executive compensation would have to be employee evaluations. If employees are granted the power to evaluate their fellow employees, then the system will typically be viewed in a fair and favourable manner. We certainly believe that using employee evaluations to base compensation rates follows procedural justice principles very closely. As stated within the text “employees perceive that procedures are fairer when they are given a say in the decision-making process.”

Q 3. Do you think the government has a legitimate role in controlling executive compensation? How might we use distributive and procedural justice theories to inform this debate?

• NO, The government can not have control over private company’s executive compensation unless someone is being injured in some type of way because of it.

• Distributive and procedural justice is how fair the type of payment is but I don’t know if the government can legally say that people’s payroll is not fair if the company is still successful. It should be investigated for other legal reasons if the payroll is out of control.

Q 4. Are there any positive motivational consequences of trying compensation pay closely to firm performance?

• Performance evaluations help dictate how annual bonuses are distributed. If an employee was a hard worker and had a positive impact on the productivity of a company, then that person should rightfully be compensated.

CONCLUSION

As per the case study the CEO’s should be given compensations on the basis of their performance rather then there status. In past there are cases where the CEO’s of big company has been paid high instead of their weak performance. The best way to deal with problem should be that, the “Employee evaluations”. If employees are granted the power to evaluate their fellow employees, then the system will typically be viewed in a fair and favourable manner. And the conflict can be resolved.