Executive employees, such as chief executive officers (CEOs), chief financial officers (CFOs), company presidents, and other upper level managers are often compensated differently than those at lower levels of an organization. Executive compensation consists of base salary, bonuses, long-term incentives, benefits, and perquisites. For the higher management, salaries are influenced by the size of a company, performance of the company, by the specific industry, and in party by the contribution of the incumbent to the process of decision-making. The more profitable the organization is the firm, the better is the compensation paid to the executives.
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.
Features of Executive Compensation
The features of executive compensation are:
- It cannot be compared to the wage and salary schemes meant for other employees in organization.
- Executives are denied the privilege of having unionized strength.
- Secrecy is maintained in respect of executive remuneration.
- Executive pay is not supposed to be based on individual performance measure but rather on unit or organizational performance.
- Executive remuneration is subject to statutory ceilings in some respects.
- Executive remuneration depends on competence, experience, length of service, loyalty to founders, excelling areas like M&A specialist, turnaround specialist etc.
- Executive remuneration supposed to be guided by job evaluations, job descriptions, salary grades with ranges of pay in each grade & salary survey – but exorbitant in reality.
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.
Elements of Executive Compensation
Executive remuneration generally comprises four elements:
1. Salary and allowance
Salary is the first component of executive remuneration. Salary is supposed to be determined through evaluation and serves as the basis for other types of benefits. Salary is basically determined through job evaluation and serves as the basic for other types of benefits, but in managerial compensation job evaluation plays only a part and not represents the whole truth. A manager is paid for his capabilities and for the job he performs, rather than only job demands. This is the reason why the norms of wages and salary fixation are generally not observed while fixing the salary of the manager. Salary of the managers varies by the type of job, size of organization, region of the country and type of industry. Typically, pay of CEOs and other executives is set to be competitive with other executive salaries in the market and thus may be very high in comparison to the pay of employees in their own company. Salary makes up of about 40 to 60 % of top managers annual compensation but it is not significant, as it is subject to deduction at source and is also kept by government regulation. In order to avoid such deductions and sealing, managers are offered incentives and attractive perks.
In the base salary of executives, most receive variable pay, a compensation that fluctuates according to some level of performance. The use of compensation beyond base salary is intended to motivate executives to reach certain organizational performance goals, for example, specific profit levels, and reward them for reaching these goals. One very popular type of variable pay is the executive bonus, which is a one-time payment tied to some short-term performance goal. Bonus plays an important role in today’s competitive executive payment programmes. The bonus may be based on any number of performance outcomes, ranging from judgments of executive performance by the board of directors, to levels of company profits or market share. Nearly all executives now receive some sort of bonus as a part of their compensation package. Managers deserve bonus because they have much more stakes to influence organizational success than non-managerial staff.
3. Long term Incentives
Incentives have become important for rewarding the performance of executives, and now make up about one half of total executive compensation. Incentives are rewards that are directly linked to specific long-term goals of the organization. The most common long-term incentive is the stock option, which either gives the executive free company stock, or allows him or her to purchase company stock at a reduced price for a period of time. If bonus is short term benefits, stock options are long term benefits offered to managers. These stocks become more valuable as the company improves financially, and therefore, ownership of stock is intended to encourage the executive to make the organization more profitable. Executives can then sell these stocks at a later time when they have appreciated in value, therefore providing compensation beyond the employee’s tenure with the organization.
4. Benefits & Perquisites
Benefits for executive-level employees are also likely to be different than those offered to lower-level employees. Executives will often receive high levels of typical company fringe benefits, like health insurance, life insurance, and pension plans. Additionally, some executives may also have a contract for large severance packages, paying cash and stock options to a CEO fired from a company. Many executives negotiate generous severance packages at the time of hire, so that even if they are unable to deliver upon promises to the company, they can collect compensation upon exit.
Executive perquisites, or “perks,” are special benefits and services for executives and other top employees of companies. Perks may be things such as a car service, an executive dining room, special parking, membership in clubs, and other such amenities. Some of these perks, like car service or a company airplane, may serve to improve an executive’s ability to do his or her job. Additionally, some perks bring with them a certain level of status, for example company-paid membership to an exclusive country club that is appealing to executive employees. Executive compensation may include other benefits which other employee do not receive. Moreover, executives are compensated for the various expenses incurred by them, for taxation takes away a major portion of their salary. Such payments are in the form of ;
- Medical care;
- Counsel and accountants to assist in legal, tax and financial problems;
- Facilities for entertaining customers and for dining out;
- Company recreational area (swimming pool and gymnasium);
- The cost of the education and training of executives, scholarships for their children, and allowances for business magazines and books; and
- Free well-furnished accommodation, conveyance and servants.