Kluyver, C. (2013). A primer on corporate governance (2nd ed.). New York, NY: Business Expert Press.
However, there have been many cases where the CEO and executive officers receive outrageous compensation even when the companies suffer. Overall, there is a wide disconnect between the incentive of the executives and the financial performance of their company, which needs to be fixed. By passing regulations and rules such as the Dodd-Frank Act, there is hope of shedding light on the connection between the company’s performance and the executives pay. Although it will provide a clear insight, it will not be able to set a strict regulated compensation or define what an executive should earn. Instead regulations will allow for more transparency for the shareholders regarding corporate governance issues such as executive pay. Along with that, it will force companies to take accountability for their actions. If they do poorly, then the executives should be paid less, and vice versa. Overall, there should be a direct alignment between executive pay and the company’s
Directors have awarded compensation packages that go well beyond what is required to attract and hold on to executives and have rewarded even poorly performing executives. These executive pay excesses come at the expense of shareholders as well as the company and its employees. Furthermore, a poorly designed executive compensation package can reward decisions that are not in the long-term interests of a company. Excessive CEO pay is essentially a corporate governance problem. When CEOs have too much power in the boardroom, they are able to extract what economists' call "economic rents" from shareholders (Economic rent is distinct from economic profit, which is the difference between a firm's revenues and the opportunity cost of its inputs). The board of directors is supposed to protect shareholder interests and minimize these costs. At approximately two-thirds of US companies, the CEO sits as the board's chair. When one single person serves as both chair and CEO, it is impossible to objectively monitor and evaluate his or her own performance.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 gave the right to the shareholders to be able to approve the executive compensation for a company, in this case the Kroger Corporation. However, this is only on an advisory basis which is nonbinding. Meaning, if Kroger so chooses, it may not follow the executive compensation decisions made by the shareholders. Ultimately, the power to set the executive compensation is given to the Compensation Committee. Kroger wishes to retain the best management possible, and it does so through competitive pay. Kroger believes that a significant amount of the pay should be based on performance and the proportion of responsibility held by the executive. They also believe compensation should
Generally, under-performing companies are the prime targets of hostile takeovers, so it makes sense that aligning shareholder and executive goals is a major way to avoid that. One popular way of aligning these goals is through the use of elaborate, structured compensation plans for executives which directly tie an executive’s salary to the performance of the company, usually and specifically its stock price (Megginson & Smart, 2009). These compensation plans have become the norm for American corporations, and their effectiveness in solving the agency problem is debatable. On one hand, it should drive an executive to strive to maximize the shareholder wealth, and it also helps companies to attract and retain the best available managers. On the other hand, it serves to sometimes wildly inflate the compensation paid to these executives, either by corporations trying to stay competitive for the best talent, or through easily achievable goals and uncapped maximums. The structured plans, if done correctly, are an effective way to help insure the goal of wealth maximization, but they are also by definition agency costs. Hence, agency problems are inherent to our American corporate system.
The main foundation of executive compensation has not changed, it is designed to attract, inspire, motivate and in the end retain the superior talent in the management world. In 2008 a government fund TARP was “created to purchase troubled assets from financial institutions” (Bruvik & Whitney Gibson, 2011, p. 79). TARP funds put restrictions on executive compensation by; restricting paying out bonuses, limiting the “Golden Parachutes”, denial of benefits and used clawbacks if executive compensation was based on misleading statements (Bruvik & Whitney Gibson, 2011). In order to receive TARP funding, firms have to practice the US mandatory “Say on Pay” which was implemented in January 2011. The United Kingdom has also implemented the “Say on Pay” concept. The “Say on Pay” is a concept that “shareholders should be given a nonbinding vote on board of director’s
In order to examine the effects of excessive CEO pay on the company’s stakeholders, one must define the two terms. Russell S. Whelton, a former graduate student at Saginaw Valley State University, defines excessive pay as, “compensation that is 20% or greater than the national average CEO salary” (Whelton 15). Therefore, excessive pay would constitute compensation over $13.8 million per year (Chamberlain). A stakeholder is anyone who is directly affected by the performance of an organization and thereby, holds a stake in that company (Schermerhorn 73). Some examples of stakeholders are directors, shareholders, executive officers, and all employees. It is important to understand why executive officers are compensated at the high levels they are today to determine the benefits and disadvantages of the argument. The purpose of compensation at any higher level is to “attempt to ensure that management actions result in successful performance for the firm” (Ashley and Yang 369). Possible excessive compensation can be a result
As of October 2013 the ‘Enterprise and Regulatory Reform Bill’ was amended by parliament under the proposal of Vince Cable , the new powers gave shareholders a binding vote on executive compensation , this meant that any changes in executive pay required a 50% shareholders approval. Before this shareholders votes on such matters were advisory , this meant even if there was a vote against executive pay they could still be increased regardless. This is significant as it shows a change in peoples perception on the role of shareholders within a company and leads to the point if this is correct.
Executive compensation packages have been used both successfully and unsuccessfully to solve the principal-agent problem facing corporations these days. In this study, we focus on a specific element of an executive compensation package, stock options. The use of stock options as a form of senior executive compensation has been studied extensively to be a testament to the success of it’s ability to realign executive with shareholder interests. However, as the study reveals, prior to the Sarbanes-Oxley Act of 2002, there were many problems with the usage of stock options within corporations that had a weak corporate governance structure. Problems included executive’s incentives to focus on short run profit, take on risky business strategies, and manipulations (legal and illegal) to fulfill executive self-interests. While it is difficult to measure the true effect of stock option’s influence on executive performance and behaviors, we see that the problems with stock option usage far outweigh the benefits of stock options prior to the implementation of the Sarbanes-Oxley Act.
Executive compensation has been at the forefront of discussion for a long period of time. Analyzed by academics, highlighted by the media, questioned by Congress, and scrutinized by the general public, the topic warrants much debate. In the 1990’s, total executive compensation increased substantially as companies began offering stock option programs; CEO’s of S&P 500 saw an average increase of 150%.
This paper looks at the opinions and issues involved within executive compensation. This is important because executive compensation is such an integral part of a company or organization’s functions. Executives are the ones tasked with making the decisions within an organization, and their pay can sometimes be linked to how well or how not well their decisions pan out. To look at these opinions, research and high quality analyses from various data sources were used. Some of these sources included the in-class textbook, “Compensation” by George Milkovich, Jerry Newman, and Barry Gerhart. While other sources used, included peer reviewed journals as preferred by the professor. All of these sources were used to show the relevance between executive compensation and compensation management as an entirety. The results are across the board; there are issues and opinions that clearly contradict each other and individuals take many different stances on the topic of executive compensation. The conclusion is that this will continue to be an ongoing and sensitive topic to discuss within organization structures and plenty more research and data will arise for individuals to gain further and deeper understanding of the complex nature of executive compensation.
Before the compensation committee can decide how much to pay its Chief Executive Officer (CEO), the committee must first understand why effective managerial pay strategies are important to the corporation. Executive pay must function not only to attract the most talented and dedicated managers, but also to align CEO intentions with shareholder wishes. These so-called agency problems are at the heart of the debate of executive payment schemes. Michael Jensen explains in a 2002 article, “a rational manager with no investment in his firm would have little incentive to maximize its value, and every incentive to use it for his own ends” (Jensen para. 3). This is exactly the conflict which the compensation committee must avoid. The most basic (and practiced) method of avoiding this problem is to issue a portion of an executive’s compensation as stock and/or require the executive to hold a certain amount of stock ownership in the company. “A CEO who does not own a portion of the residual claims of the firm faces little direct incentive to maximize
Despite these potential limitations above, this report demonstrated the role of CEO power on designing compensation contract, and it also provided some implications for regulators on company governance. To suggest the possible research extension, it could be held to control and limit CEO power. It also can be how to avoid that CEO power influence the compensation contract design and how to solve this problem that CEO has significant power. For example, it can research how to build an efficient compensation committee and how to improve the audit and supervise system about CEO power.
Executive compensation is a form of financial compensation that is determined by the compensation committee. The compensation committee sets the package so it correlates with factors that have an effect on the company. According to an economic theory known as the “Optimal Contracting Theory.”, top executives and shareholders negotiate through the board of directors to maximize their respective interests (Managerial). A principal/agent problem arises because shareholders need to get the
This was a very interesting article, in my opinion it brings to mind the derived phrase, which came first the chicken or the egg. Meaning, is corporate governance an attempt to control the results of unethical practices of corporations or is it meant to deter them. In reading this article, it is clear that certain corporations practiced unethical business behaviors for self-interest, but the questions this author have are: 1. Should corporate governance be regulated by the legislature as well as the organization and to what degree, 2. Is corporate governance, there to protect the shareholder or the stakeholder, 3. How effective is corporate governance on a global level. The need for a governance system is based on the assumption that the separation between the owners of a company and its management provides self-interest executives the opportunity to take actions that benefit themselves, with the cost of these actions borne by the owners (Larcker & Tayan, 2008).