An executive is a person who is a member of the highest decision-making group in an organization. Chief executive officer (CEO), full-time directors and other senior managers fall in this category. Executive compensation includes base salary, bonus long-term incentives, and perquisites (perks) payable to executive. Executive compensation has become a hot topic in compensation management. It has become a hot topic globally because it differs from compensation plan of other employees. The difference is in the following ways:
- Executives are in a position to fix their own compensation package within the guidelines framed by an organisation or guidelines framed by the government.
- Executive frequently operates under bonus and stock option plans that can dramatically increase their total compensation. Because of this phenomenon, the gap between executive and non-executive remuneration is widening at an alarming rate, from 80 per cent in 1980s to 400 per cent in 1990s. According to a report from Time Magazine, top five executives account for about 75 per cent of stock options while 15 per cent options are accounted by another top five per cent. These figures compel people wonder whether the CEOs are busy managing the company or the share prices.
- Executives are offered perquisites that are not available to other category of managerial personnel. Such perquisites may include free housing, company’s vehicles for personal use, free insurance, liberal expense accounts, post-retirement consulting contracts, and so on.
- In many cases, executives have the benefit of golden parachute. It is designed by the executives as a means of protecting themselves if a merger or hostile takeover occurs. Such a parachute typically provides either a severance compensation to the departing executive or a guaranteed position in the newly created entity.
Factors Affecting Executive Compensation
For making an executive compensation plan rational, those factors should be taken into account which affect executive compensation. Such factors are as follows:
- Complexity of the Job: The degree of complexity in an executive’s job is much higher as compared to other organisational jobs. Such complexity is directly dependent on size of organisation lines of products/services, and geographical area coverage. Thus, in an organisation of large size with multilines of products/services and multi-locations, the degree of complexity in the executive’s job is much higher. Naturally executives in such organisations need to be paid more. Executives of Fortune 500 companies draw much higher compensation than their counterparts in other companies.
- Competency Required: Different jobs require different types of competencies. Organisations that operate in a comparatively stable environment (like traditional manufacturing sector) adopt mechanistic-oriented systems which require comparatively lesser flexibility and variety in executives’ competencies. As against this. organisations that operate in a highly dynamic environment (like consultancy, information technology, etc.) adopt organic-oriented systems which require high flexibility and variety in executives’ competencies. In the latter category organisations, the level of executive compensation tends to be higher than the former.
- Capacity to Pay: Executive compensation depends on the paying capacity of an organisation. Paying capacity is directly dependent on the earning capacity of the organisation. Thus, growing organisations are in a better position to pay more for its executives than stable or declining organisations; high-profit-margin organisations can pay more than low profit-margin organisations.
- Organisational Philosophy: Organisational philosophy regarding attracting and retaining human talents, particularly key executives, affects the level of executive compensation. An organisation which believes in getting “the best-in-class executives” pays much higher than those organisations who do not have such a belief. In fact, for many organisations, executive compensation is not a constraint because of their philosophy of hiring the best.
- International Impact: International human resource management practices, including executive compensation practices, have their impact on the executive compensation practices of many countries. India is no exception to this. With economic liberalization, many multinationals have entered India which pays quite high compensation to their executives. Further, Indian executives are placed by these organisations on global assignments with an opportunity for substantial saving. This practice has compelled Indian organisations to make their executive compensation level near par with that of multinationals.
- Legal Provisions: Legal provisions also affect the level of executive compensation. In India, legal provisions exist under the Companies Act, 1956. that restrict the managerial compensation. These provisions are as follows:
- Total remuneration payable to managerial personnel – 11% of profit payable
- In case of one managing/whole-time director – 5% of profit payable
- In case of more than one managing/whole-time director – 10% of profit payable
These restrictions are applicable to public limited companies and their subsidiaries. These are not applied to private limited companies. A perusal of these restrictions shows that for high profit-earning company, these restrictions hardly put any constraint in making hefty payment to their executives. An analysis of executive compensation shows that executives get much more than what other category of employees in the same organisation get.
Whether ideologically, this is justified or not but in the present era of talent war, it is justified. An old proverb “if you pay peanut, you can get only monkey” holds true in this case. Paying higher to an executive is justified provided he deserves it competence-wise.
Credit: Compensation Management-CU