A Fair Executive Pay System

Unlike other managerial positions where pay is determined by salary policies and budgets, CEOs and other executives only need to get their corporate board to agree on a fair level of compensation.Surveys indicates that 25% of board members agree that CEO compensation is too high and 50% agree it is high; however, 85% of board members report their CEO’s compensation program is effective. It seems that even though corporations know they overpay their top-ranked employees, many companies still do not enact changes to such salary policies.

As a result, President Obama imposes a cap of $500,000 upon companies that receive federal assistance in an effort to reduce the pay level.The public suspects that this is only a preventive action, not a proactive solution. Similar actions occurred in 1993 when Congress imposed a $1 million cap on CEO salary tax deductibility; it then led to other forms of compensation, such as stock option grants. It is difficult to create a fair system when management and board members are not independent. In some companies, the chair is also the CEO and cannot be described as an independent chair since he has influence on other board members. In other cases, the boards often say yes to top leaders as they are professional investors and their main concerns are profits.

One alternative is to increase shareholder involvement by adopting the “say on pay” policy. This encourages shareholders to get involved in the choice of performance measures, raises the voice of the minorities, and strengthens corporate governance between management and institution owners. However, most investors want more profits and pressure executives to generate more revenues, hence encouraging risk taking. Therefore, the bad aspects of this alternative are risky courses of action to run for profit, while switching the blame to shareholders. Besides, executives can always act in advance to avoid confrontation with shareholders and still get away safely.

Having government involvement to set a uniform compensation structure tied directly to revenues or profits is another option. The benefits are a transparent compensation plan, limited unnecessary risk taking, and enforceability. However, such interference could discourage innovative leadership especially when the companies are struggling with losses. Managers tend to act safely and generate more bureaucracy to comply with new rules. Besides, there is fewer room for board members to incentivize long-term performance.

Others suggest corporations should award most compensation as deferred stock bonuses and tighten their provisions for clawbacks based on profit projections or risk evaluations. The advantages are eliminating unnecessary risk-taking actions, encouraging integrity, and aiming for long-term economic benefits. However, it does not improve the overall context where losses were already incurred. Besides, this option navigates to the original query which asserts that nothing goes wrong when the company performs well.

Currently, corporations need to adopt tougher rules to seize pay from employees who were found to take excessive risks or did not prevent risk-taking actions. To make employees financially responsible for their mistakes is a step in the right direction. The next step could be allowing outsiders to access necessary information to determine if clawbacks are effective. Clawbacks should allow firms to reclaim compensation for up to three years after the stock options are awarded. Lastly, companies could adopt a holistic approach that tailors executives’ pays to a company’s individual circumstance, rather than allow government to set a general fixed pay structure. “Say on pay” can be used as a mean to let shareholders pay more attention to management. Collective involvement of multiple stakeholders will shape the praise or blame that is to come in the future.

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