CEO Compensation Must Drive Productivity
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 according to set targets.
Take due care 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.
For example, there are 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.
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.
Are they making the right decision on CEO compensation? In order to get there, they need to ask the right questions. They 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.(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.
Main Responsibility of CEOs
CEOs' compensation does not fail to attract criticisms for many reasons.
CEOs are the highest paid employees since they play the important role, among other roles, of HR strategic business partner.
This is why their main responsibility is to increase organizations' shareholders' value as well as to look after the interests of other stakeholders.
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.
Interests of Stakeholders
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.
- There is evidence that some CEOs' pay is related to companies' performance. (Article by Kevin J. Sigler, Joseph P. Haley, 1995)
- CEOs' compensation changed very little during economic recession. And "that the link between CEO pay and firm
performance remains very weak." There was a great decline in shareholder value. (The Corporate Library Survey 2008)
- CEOs can easily survive during recession. (Rick Newman, 2009)
Find out the reason(s) why.
- Possible connection between CEOs' pay, performance and nation's economic growth. (As reported in www.chiefexecutive.net, 1999)
- CEOs' bonus increases correlate to companies overall performance. (Mercer Annual Study of CEO Compensation, July 1 2005)
- Setting the maximum range of CEOs' pay will help create responsible corporations. (David Moberg, March 23, 2009) Click HERE for more info
Components of CEOs Compensation
These may consist of:
- Base Pay
- Bonus, Contractual or Performance-Based
- Benefits such as Medical Insurance, Vacation Leave
- Incentives such as Share or Stock Options
- Severance Pay for termination "without cause"
- Golden Handshake which is similar to severance pay
- Other Termination Benefits such as continued use of company's facilities, for example, use of company's swimming pool for a specified period of time
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.
Design an Effective CEO Compensation
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 an effective compensation model for the CEO. Of course, they also need to determine the compensation package for the entire workforce. HR professionals can provide the necessary assistance in its design.
An effective CEO compensation is tied to the financial performance of the organization.
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:
Return on Equity = Net Income/Shareholder's Equity
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 CEO 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 stated in the employment contract.
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