An effective CEO compensation plan is one that is well balanced in terms of quantum, the scope of duties and responsibilities, leadership quality, and effectiveness in driving organizational performance to a higher level based on set targets.
Due care is required when formulating a compensation system. Organizations cannot pay an unreasonably high salary and offer a string of benefits to their CEOs. However, offering a "poor man's compensation package" is as bad. Aim for a balanced and equitable CEO compensation package commensurate with the level of responsibilities and also competitive within the industry concerned.
There were instances of CEOs who continue being paid high salary although they are not doing a good job as corporate leaders. Clearly there is no contractual term specifying salary reduction for poor performance or in the worst case scenario, termination of service.
CEOs have specific expectations about the quantum and the components of their pay, and certain benefits they can enjoy, among others. There are reports of CEOs who are paid high salaries because of the importance of their positions. But there are also CEOs who fail miserably at their job. In these cases, the organizations may have a poorly-designed CEO compensation policy.
CEOs are not the only party concerned with this important but difficult and sensitive matter.
Compensation is very high in the organization's agenda. Boards of Directors have the final say on this matter. It goes without saying that they cannot let their guard down. After all, they will have to answer to stakeholders. What they pay must reflect excellent performance by the CEO on the job.
Is the organization making the right decision on CEO compensation? In order to get there, corporate leaders need to ask the right questions. To do this,t hey need to have the right information on what drives productivity.
Reports of mismanagement of high-profile organizations come up from time to time. Vigilance and good governance are critical on the part of directors.
There are others who closely watch CEOs pay. Loop-sided CEO compensation usually cannot escape criticisms from compensation experts and the public.(Loop-sided: not balanced; biased towards one party)
Governments sometimes intervene indirectly to force organizations to correct poorly-designed pay package of CEOs. When large corporations fall, governments of the day suffer and may lose in the next election.
Other stakeholders are interested in matters of compensation. Stakeholders would include financiers, investors, suppliers, customers and clients, and employees.
Criticisms alone will not resolve problems of CEO's pay-responsibilities imbalance. Some organizations may decide that the criticisms are a nuisance and unimportant. But right-minded organizations will take positive actions to put things right. This is to avoid government intervention.
Likewise, right-minded CEOs are well aware that the stakes are high. Their style of leadership may or may not ensure the organizations' continued success, and even existence. And they cannot expect to stay if their performance is poor.
Criticism of CEOs' Compensation
The compensation paid to CEOS is criticised for many reasons.
CEOs are the highest paid employees since they play the important role, among other roles, of HR strategic business partner.
It has been said that CEOs' main responsibility is to increase organizations' shareholders' value as well as to look after the interests of other stakeholders. (Some commentators have said that increasing shareholders' value is no longer the most important responsibility.)
The high pay of CEOs is aimed at motivating them to perform to the highest possible level of the highest standard.
They are there to make their organizations move forward during both good and bad times. This is a tall order. But this is required of their highly-paid and prestigious positions.
Stakeholders include both internal and external customers, shareholders, as well as the government and banks.
The stakeholders in public companies differ to those in private companies especially shareholders in the former case who exercise control over such companies.
"Value" may refer to the value of shares or some other returns on the investments made by people in the organization.
Individuals look forward to dividends on their investments. Banks expects to earn through the interests on the money they had loaned to businesses. Owners look to the appreciation in the overall value of their companies.
Whether it is a company financed by equity financing, debts, or investment by private individuals, "increasing value" is an effective measure of CEOs' performance and whether they can retain their positions for the long term.
To put it bluntly, failure to perform means heads must roll.
Poorly-Designed CEO Compensation Package
Instances of poorly-designed pay package continue to occur.
Among some of the interesting things reported regarding the connection of CEOs' pay to increasing shareholders' value include the following.
Components of CEOs Compensation
These may consist of:
It was reported that in one CEO appointment, one of the termination benefits was that the company shall engage the CEO as a consultant. Arrangements like this and some of the items above, such as the continued use of the swimming pool, cannot escaped criticisms.
If your organization binds itself to employ the ex-CEO as a consultant, you may end up having a consultant who had performed badly as a CEO.
You may not easily get out of this situation if the CEO contract had not clearly stated the conditions under which your organization can terminate the CEO's appointment as a consultant.
CEOs determine whether the organization will succeed or fail. Make the right choice for a CEO.
There are other players but he plays the most important role, being the corporate leader.
The board of directors need to adopt a fair and effective CEO compensation model. Of course, they also need to determine the compensation package for the rest of the workforce. HR professionals can provide the necessary assistance in designing it.
CEO compensation is closely connected to the financial performance of the organization. Failure to perform means it is time to go.
CEO's Performance Measure
Shareholders' value shall form the performance measure for CEOs especially of public-listed companies. This is measured by "Return on Equity," "Profit Before Tax," "Profit After Tax and Special Items," and other financial performance measures. It is usually stated as:
In other cases, the main key performance indicator (KPI) is Return on Investment. This is a measure in cash, in monetary value.
Satisfactory performance which can mean average performance will most probably not satisfy the criteria. CEOs need to demonstrate ability to generate revenue higher than the "break-even point" or even higher.
Anything lower should invite scrutiny that may involve the possibility of termination. The employment contract must clearly state these terms to prevent any form of misunderstanding or misinterpretation.
Review of CEOs Compensation
Conduct a regular compensation review to ensure its continued effectiveness. Make an overall review once in three or five years.
It is a good idea to review CEO compensation each year at the end of company's financial year. Have this inserted in the employment contract.