Ceo Compensation

Executive Compensation

Jing Jia

(School of Management, NJIT, Newark, NJ)

Abstract

This paper sums up the theoretical background for executive compensation and depicts a comprehensive and contemporary situation of pay practices. It also foresees future trends for executive compensation. Topics discussed in the paper include CEO incentive compensation principle, alternative approaches to executive compensation (including salary, bonus, restricted stock, and executive stock options), comparison of the restricted stock and stock options, principles of executive pay design, and the relation between CEO performance and pay.

Keywords: Executive compensation, incentives, executive compensation plan design, CEO performance and pay, key component

Theoretical background

Executive compensation is how top executives of business corporations are paid . Although there are different pay practices methods for CEO stretching across industries and enterprises, the most administrative executive compensation contains four basic components which are: salary and wages, an annual bonus bind to performance, executive stock options, long-term incentive (including restricted stock plans and multi-year-based performance) . Moreover, executives also can get what employee benefits offered, such as health insurance, retirement benefit, life insurance and so on. When compared with other level management, CEO also have good conditional and long term employment contract with a base salaries, annual bonus payment tied with performance and not influenced by the changes of enterprise control.

The key Components of executive compensation

1. Base Salaries excludes any income that an individual may be permitted to earn outside of duties to the applicant organization. The Executives’ base salary should be decided by the owner of the firm through a broad survey to benchmark position across the general industry. Then the firm should be supplemented useful information for market data. Finally, according to different size of the company, and the different pay level of executives, the company can decide the base salaries for the compensation.

Executives pay more attention to the process of determination of the base salary, although it just occupies very small share of the whole compensation system. So the reasons include 3 aspects: (1) Base salaries are very important to the employment contracts for executives, which could assure minimum benefits the executives can get in the following years. (2) Other components, such as bonus and dividend, are related to base salaries closely. For example, bonus usually dispatch according to the percentage of the base salaries. (3) Executives believed base salaries are manifesting of their value and ability. Since the determination for base salaries through broad survey and comparison across the general industry, so the base salaries reflect the level of benchmark position.

2. Bonus Plan is usually paid at the end of each year according to the executives’ yearly performance, and it often calculated by the profit the company got annually or the percentage of the base salaries. In order to get the maximal benefit and bonus, the executives should try their best to operate the company going well, since the bonus are earned through their performance but not granted no matter what they did. There is a direct relationship between the executives’ performance and accomplishment they reach and the bonus payment plan. Bonus plan is a good incentive to executive to work hard, it can be paid quarterly or yearly, but most companies pay it yearly in order to prevent the short-term performance from the executives.

There are no forced criteria in establishing bonus plan; each company could design bonus paying rules by its own situation. Some believed paying low salaries and highly bonus will promote executivesвЂ™Ð²Ð‚™ behavior, other believed exact reverse. No matter how they believed, fit the need of the company is the most important aspect. In addition, the criteria for design bonus plan should be simplicity and quantifiability , it should be very easy to communicate with the executives and suitable for their real ability.

Not all the organizations are suitable to use bonus plan as an incentive for executive compensation. For example, some small companies may face the problems that conducting the plan added heavy burden for their administration which exceeded the advantages that the bonus plan can offer. A newly set up and fast growing company will have big profit in the first few months or even in the first few years, so yearly bonus plan will cause them to pay too much than ordinary period, so it may be not fit for these companies. In addition, some enterprises do not have the management information system to be able to suitable for the performance appraisal activities that block the conducting for the bonus plan.

Bonus plan can be offered in different types, not all the bonus is offered in monetary. Companies can decide which type plan is suitable for them, the approaches of the bonus plan included: Merit Pay, Competency-Based Pay, Skill-Based Pay, Profit Sharing, Gain Sharing, Recognition Awards, Contribution Awards and Non-monetary Awards. Any way, the annual bonus is an indispensable incentive in a company for motive executives work hard and bring profit for the company and shareholders, which can bind closely between executive compensation to the financial performance of the company.

3. Restricted stock is a special incentive designed for some specific plan. It refers that the right which executives sell this kind of stock is restricted which means the executives have the power regarding the stock is restricted to certain conditions (for instance, limited to three years). Executives do not need to pay for the stocks when they were granted, but they have no right to sell, transfer or impawn the stocks within the limited time, if the executives resigned or have been dismissed in this period, therefore, the stocks are confiscated. The goal of the company to implement restricted stock is to motivate executives to contribute more time and energy into some or certain long-term strategic target of the company.

From the design of the restricted stock, the restriction shows in two aspects: one is the condition of acquisition; the other is the condition of selling. But in common view, it mainly refers to selling condition. And the approaches of design basically rely on the realistic situation of each company and have flexibility.

4. Stock Options means the executives have the right to purchase stocks of the