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    Compensation Management, 2e: © Oxford University Press 2015. All Rights Reserved

    Uploaded by

    Ipsita Satapathy
    Execu Compen

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Flag for inappropriate content
    Download as pdf or txt
    of 15

    Compensation

    Management, 2e
    Dipak Kumar
    Bhattacharyya
    Oxford University Press 2015. All rights reserved.

    Chapter 11

    Executive Compensation

    Oxford University Press 2015. All rights reserved.

    Introduction
    Executive compensation correlates with organizational performance.
    There are three main areas of focus in executive compensation:
    Understanding the criteria

    Understanding the consequences


    Mechanism to determine executive compensation

    Oxford University Press 2015. All rights reserved.

    Components of Executive Compensation


    Components of executive compensation are:

    1.
    2.
    3.

    Variable pay such as bonuses, commissions, and profit sharing


    Base pay such as salary and perquisites
    Employment status such as promotions and termination

    Effective executive compensation packages typically comprises of the following


    components:

    base salary
    annual incentives
    long-term capital accumulation
    deferred compensation arrangements
    supplemental benefits and perquisites
    special severance and retirement arrangements
    employment and change of control agreements(golden parachutes)

    Oxford University Press 2015. All rights reserved.

    Emerging trends in executive compensation


    Following are some emerging trends in executive compensation.

    Increase in the number of corporate meltdowns is now dragging executive


    pay and corporate governance into the public domain.
    Business conditions are putting pressures on existing pay levels and
    structures.
    Corporate restraint and accountability make controlling executive
    compensation a major issue in tough economic times.
    Executive compensation movements at the median of the market are
    getting subdued over the years.

    Oxford University Press 2015. All rights reserved.

    Executive compensation theories


    Most executive compensation theories centre on the theories of firms. With profit
    maximization as the core objective, firms rely heavily on their executives. This
    syndrome encourages executives to expect above normal compensation.
    Theories of executive compensation centres on following issues:

    Organizations need to identify executive compensation options that help


    them derive benefits of performance satisfaction and increased executive
    retention.
    Perquisites and supplementary benefits represent a very small fraction of
    executive compensation due to tax burden.
    Organizations need to design tax-efficient long-term incentive packages.
    Organizations link executive compensation to sales maximization
    hypothesis.

    Oxford University Press 2015. All rights reserved.

    Executive Compensation theories


    Other important economic determinant of executive compensation is
    the performance of the firm. Executives are accountable for the firms
    performance. Hence, their compensation is linked to the results of
    organizational performance.
    Executive compensation can also vary with the type of industry. For
    example, the compensation packages in the service sector are higher
    than those of the manufacturing sector.
    Another important economic variable is the difference in value of
    human capital.
    Political and social factors also influence executive compensation.
    Important theories of executive compensation are as under:
    Agency theory, which suggests designing of executive compensation based on the
    mutual interests of the agents (executives) and shareholders (principals).
    Tournament theory, which views executive compensation as the prize in a series of
    tournaments or contests among middle and top-level managers.
    Oxford University Press 2015. All rights reserved.

    Executive compensation theories


    Social comparison theory, which suggests designing executive compensation by
    comparing it with similar individuals.
    Balance sheet approach, which aims to provide expatriates compensation based
    on the standard of living they normally enjoy in their own country.
    Headquarters-based pay, which refers to executive compensation to all according
    to the rate used at headquarters.
    Golden handcuffs, which refers to payment of above market rate executive
    compensation.
    Competency-based pay, which refers to a pay directly related to the kinds and
    levels of competencies required in the performance of the work or job

    Oxford University Press 2015. All rights reserved.

    Executive compensation theories


    Golden parachutes, which refers to the practice of providing pay and benefits to
    executives after their termination resulting from a change in ownership or a
    corporate takeover.
    Cafeteria plan, which gives executives the option to choose different types of
    benefits, which is commonly known as the cafeteria plan.
    Profit-sharing plan, which provides direct or indirect payments based on the
    organizations profitability, apart from regular compensation.

    Oxford University Press 2015. All rights reserved.

    Executive Compensation Design


    Executive compensation design process links compensation criteria such as
    organizational performance or size to compensation consequences such as pay at
    risk.
    Such process or mechanism is categorized into two formsthe process that
    centres on contract and the process that involves direct monitoring of the
    executive.
    Organizations that follow the contract process make it a time-bound employment
    offer, which becomes a legal arrangement. Contracts specify criteria for
    compensation, basis of compensation (in the form of schedules), and some
    predictable conditions for linking compensation consequences to criteria.
    Direct monitoring is a behavioural approach to monitor the performance of the
    executive. It is a subjective evaluation. It is based on the principles of agency
    theory.

    Oxford University Press 2015. All rights reserved.

    Typical executive compensation component

    Oxford University Press 2015. All rights reserved.

    Executive compensation and organizational


    strategy
    Organizations need to design executive compensation to reward the work, which will then
    by default fulfill organizational strategy.
    Designing executive compensation in the era of economic uncertainty, while rationalizing
    expectations of the executives and fulfilling organizational strategy, is a very challenging
    task.
    Following are some action plans to meet this strategic intent, while retaining a trade-off
    between executive compensation and organizational objectives:

    Optimize the cost of compensation for health and welfare benefits, while identifying
    vendors.
    Rationalize the compensation budget by restructuring the deferral components of
    compensation.
    Optimize the cost of retirement benefits using funded pension assets through stock
    build-up.
    Identify wasteful HR costs by reviewing and restructuring the terms of contracts.

    Oxford University Press 2015. All rights reserved.

    Different criteria of executive compensation


    Some important perspectives of executive compensation are:

    Strategy criterion - The strategic dimension of executive compensation


    focuses on the rising cost of compensation, which for many organizations is
    their second biggest expense.
    Role or position criterion This criterion links executive compensation
    to job position as a strategy to stimulate others to achieve the same results.
    Individual characteristics criterion This criterion argues that the
    amount of human capital possessed by executives influences their
    productivity and, thus, should influence their compensation.
    Performance criterion This criterion emanates from the agency theory
    approach, which suggests linkage of executive compensation to the firms
    performance.
    Behaviour criterion This criterion is associated with the monitoring
    mechanism, and executives take strategic initiatives while making a
    subjective analysis of business decisions. Therefore, executive
    compensation design based on behaviour criterion makes sense.
    Oxford University Press 2015. All rights reserved.

    Different criteria of executive compensation


    Size criterion As per this criterion, size of the organizations is the determinant
    of executive compensation.
    Market criterion This criterion argues that market forces (supply and demand
    for executive talent) determine executive pay.
    Peers compensation criterion This criterion suggests that the compensation
    of selected peers may play a role in setting executive pay. It is based on the
    principles of social comparison approach.

    Oxford University Press 2015. All rights reserved.

    Say on Pay and Executive Compensation


    Excessive executive compensation even at the cost of stakeholders interest has
    now become a global issue.
    Increased compensation to those in the C-suite, even when the organization is
    struggling to survive is common across the world.
    Say on pay is a movement, which gives opportunity to companys shareholders to
    oppose or approve executive compensation by voting against or for it.
    Such shareholder endorsement on executive compensation has almost now
    become essential in public limited companies. .
    In India also say on pay movement is visible.

    Oxford University Press 2015. All rights reserved.

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