The Purpose and Importance of Executive Compensation
Long-term incentives are essential for rewarding performance.
While long-term incentives are essential to executive compensation, companies are increasingly concerned with maximizing payouts. Increasingly, executive pay is subject to political pressure from activist shareholders and an increased focus on executive gender pay. In addition, the Fairness Act would require companies to report executive pay by gender, geography, and race. But, despite the potential downsides of long-term incentives, these plans are essential for rewarding performance and minimizing risk.
The objectives of long-term incentives vary considerably. They usually target a specific level of performance. The better executive performs, the greater the long-term motivation. Alternatively, long-term incentives can be divided into short-term and long-term forms, ranging from bonuses to annual incentive plans. Effective long-term incentive programs balance the interests of the executive with those of the company, regulators, and shareholders.
Creating an executive compensation plan
Creating an executive compensation plan begins with a review of the organization’s compensation plans. Market data, such as average base pay, and short-term and long-term incentives, are valuable tools in developing a competitive compensation plan. You can also consider labor market data to determine how difficult it is to fill an executive position. After reviewing market data, you’ll know what to include in your executive compensation plan.
Depending on the industry, an executive compensation plan may include both individual pay and group incentives. While personal income is tied directly to individual performance, group incentives may be linked to a company’s overall performance. This plan may make recruiting and retaining a more qualified executive easier by emphasizing performance-related compensation items rather than a fixed salary. A combination of these factors may prove to be an adequate compensation plan. The right compensation package can also differentiate between retaining a key executive and attracting a new one.
According to a new Mercer survey, CEO bonuses make up 26 percent of a CEO’s full pay. While bonuses were 16 percent of total compensation in 2002, they’ve doubled to 26 percent. While CEOs receive large bonuses, they’re not getting the same rewards as other managers. CEOs must do more than boost the stock price to increase their pay.
During the financial crisis, CEO pay skyrocketed. After years of slow growth, CEO pay packages ballooned. Some companies had CEOs receiving pay packages worth more than $300 million. As a result, boards of directors were willing to reward CEOs with huge grants to stay on as CEOs.
The recent revelations of excessive executive pay at a handful of companies cast doubt on the validity of the return on capital calculation. A recent study by O’Byrne and Van Clieaf examined the returns of the top 200 companies and their CEOs’ compensation. The study also compared companies’ returns on capital with the returns of similar companies in the same industry. While return on capital is not a reliable indicator of CEO pay, it’s an essential factor to consider in evaluating executive compensation. During the Covid-19 pandemic, many companies relaxed performance targets, prompting shareholders to question the practices and metrics used to calculate pay packages.