Executive Compensation

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Executive Compensation and Shareholder Interest

The compensation of the CEO (Chief Executive Officer), and other high level executives comprises a largo portion of a company’s payroll. It is often a topic of discussion between employees, owners and shareholders. Why is their compensation so high and why can it be viewed as controversial? The goal of the executives should be to maximize profits and secure the financial strength of the company. The question has been raised if some executives are looking to promote the best interest of their firms or the best interests of their own financial security. This raises the question of how to structure executive compensation to benefit both the executive, personally and professionally, as well as sustain the viability of the company.

Overview of Executive Compensation

During the mid 1980’s executives began receiving some of the largest compensation packages ever offered. Even during the recession in the 1990’s some executive packages continued to raise In October 1992 the Securities and Exchange Commission outlined new disclosure rules requiring disclosure of executive compensation in the proxy statements (Leonard 1994). In July 2006, the SEC again amended the reporting requirements of executive compensation Among some of the changes, it provides for one number to be disclosed for total annual compensation for each executive by name along with more detailed disclosures. As stated by John W. White, Director of the SEC’s Division of Corporation Finance, “…these disclosures be made in plain English” ( “SEC Votes to Adopt Changes”, 2006, para. 1).

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Type of Executive Compensation

Cash is not the only method by which an executive can be compensated. Option grants which includes the various stock options , is another popular methods. Executive perks like use of corporate housing, cars and jets are available as well. Retirement packages granted to executives can also be part of the employment package. Long term incentive plans base compensation on performance and are favored over the deferred compensation packages due to tax implications. This is not an all encompassing list and most executive receive a combination of the options in their employment contract.

Mutually Beneficial Compensation

Concerns have been raised about executives protecting their own interests at the expense of the company. One concern is that executive pay does not have to correlate to how well the company is run (Hodges, as cited in Brush, 2005). Options backdating by executives caused a scandal to erupt and by May 24, 2006 over 25 companies were being investigated (Dolmat Connell & Partners June 2006). Backdating of stock option involves executives moving the execution date of the stock options back in time when the price was lower thereby setting the “strike price” lower than the market price, allowing greater gain to be realized when the options we exercised (Lashinsky, 2006). CEO’s also structure their employment contracts to include protection in the event of changes or restructuring of their organization. Golden parachutes are clauses for severance packages paid out to executives who lose their jobs in the event of a change of control (Boyes, 2004, pg. 242). In 2007 Robert Nardelli received approximately $210 million in cash and stock options which included a $ 20 million severance payment and $32 million in

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retirement benefits. This was a direct result of his pre-employment negotiation ( Mui, 2007).

These are the pitfalls of executive compensation not based on business performance. There are ways to align the goals of the executive with those of the corporation of which they are the agent. For example, a pay for performance clauses “… works because of the incentive effect that underpins the pay-for performance approach, If you design incentives for management that maximize long-term shareholder value, an executive will work harder to create wealth for shareholders” (Van Putter, 2007). Michael Eisner, former CEO of Walt Disney, received no bonus in 1999 due to his company’s poor performance but bounced back in 2000 earning $3.5 million in bonuses on $1.9 billion of revenue (Boyes 2004). At his departure, Disney’s “Enterprise Value” ( market value plus debt minus cash) had risen from $2.8 billion in 1984 to $69 billion in 2004 (Epstein, Retrieved 2008).

Companies like Pitney Bowes, Dell and Elizabeth Arden are employing sub committees to the board of directors called compensation committees, which serve to ensure executives are compensated properly. They are usually comprised of members of the boards which meet the independent requirements as defined by applicable law, like Section 162(m) of the Internal Revenue Code of 1986 and the listing standard of the New York Stock Exchange. This is one example of corporate governance which is defined as “..the set of processes, customs, policies, laws and institutions affecting the way a corporation is directed, administered or controlled.” Corporate governance also manages “...the relationships among the many players involved.…The principal players involved are the shareholders, management and the board of directors” (Wikipedia,

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Retrieved 2008). Implementation of these committees provide oversight to what benefits are provided to the executives.

Another more complicated way to gain greater control over executives and decisions they make entails centralizing large blocks of stock among a few individuals or companies. These are called blockholders and these blocks can effectively allow for greater control over decision made which affect the financial performance of both the company