Question

Which component of compensation is most essential to motivate executives to lead companies toward competitive advantage? Discuss your rationale. Discuss your position on executive compensation. Is executive compensation excessive or appropriate?

Answer 1

ANSWER :

Executive compensation is a very important thing to consider when evaluating an investment opportunity because it motivates the executives to lead the company towards competitive advantage. Executives who are improperly compensated may not have the incentive to perform in the best interest of the company or its shareholders, which can be costly for those shareholders or the Company. So, let us first see the types of Executive Compensation.

Types of Executive Compensation: There are many different forms of executive compensation that offer a variety of tax benefits and performance incentives. Below are the most common forms:

    Cash Compensation – This is the sum of all standard cash salary compensation that the executive receives for the year.

    Option Grants – This is a list of all options granted to the executive; the information includes strike prices and expiration dates.

    Deferred Compensation – This is compensation that is deferred until a later date, typically for tax purposes. However, changes in regulations have lessened the popularity of this type of compensation.

    Long-Term Incentive Plans (LTIPs) – Long-term incentive plans encompass all compensation that is tied to performance for tax purposes. Current tax laws favor pay for performance-type compensation.

    Retirement Packages – These are packages given to executives after they retire from the company. These are important to watch because they can contain so-called "golden parachutes" for corrupt executives.

    Executive Perks – These are various other perks given to executives, including the use of a private jet, travel reimbursements and other rewards.

And at times we need to observe and evaluate executive compensation for the best interest of share holders. Evaluating executive compensation can be a difficult task for the individual investor. Luckily, there are many tools that are now available to make the process much easier. These tools automatically parse SEC filings to pull the numbers and make comparisons designed to give meaning to raw information.

Pay Vs. Performance:

One of the most popular ways to evaluate executive compensation is by comparing pay versus performance. Unfortunately, many executives are given raises and bonuses even when their companies are faltering. Comparing pay to stock performance can help you determine whether executives are overpaid. The specific metric used most often is comparing the change year-over-year in executive pay increases to the change year-over-year in stock price. Obviously, if the change in the stock price outpaces the change in pay, the executive is not overpaid. Here is an example of a comparison for Bill Gates, who was Microsoft's CEO between 1975 and 2000, and the company's chief software architect and chairman between 2000 and 2006. Between 1998 and 2006, Bill Gates' compensation is tied pretty closely to the company's overall performance producing profits for him. When the company makes more money, Gates receives more compensation and vice versa. This is healthy because it provides executives with the incentive to perform well and increase their personal wealth. Trends showing executives receiving a higher rate than performance can mean overcompensation for underperformance – which can hurt investors both in dollars paid out and incentive to perform.

Peer Comparison:

Another popular way to evaluate executive compensation is to compare one executive to his or her industry peers. While market leaders typically have CEOs that are paid slightly more than their industries, the majority of executives should be paid on par with their peers. Here is the same example as above, except this time it's a peer comparison instead of pay vs. performance From1998, gates pay followed the ups and downs relatively with his company’s fall and rise. By which we can clearly understand that Bill Gates made more than the average executive in his industry as the company made profit along time. Sometimes, if the executive is the founder of the company, or a high-class CEO, he or she may deserve higher compensation. Because Bill Gates is both an industry mogul and the company's founder, this may explain his comparatively higher compensation. Significant deviations between these two in standard non-founder CEOs can indicate that they are overpaid.

Executive Compensation Laws:

There have been many new laws passed to help satisfy investor concerns over executive compensation. Changes in SEC reporting requirements have forced companies to include an "Executive Compensation Discussion & Analysis" section to accompany all future pay documentation in all SEC forms. This section requires a "readable" explanation of how the compensation was determined and what it encompasses.

Other laws have been more direct in curbing practices that the companies themselves use. One prime example of this was the removal of the deferred compensation tax shelter that helped many executives avoids millions in taxes. Moreover, improvements in other tax loopholes have made it much harder for boards to justify large payouts and hide these payouts from investors.

Conclusion:

Executive compensation is a very important issue for investors to consider when making decisions. An improperly compensated executive can cost shareholders money and can produce an executive who lacks the incentive to increase profits and boost share price. Meanwhile, the government is working to curb the problem with new laws that close loopholes and make the process more transparent. Combined with new analysis tools, investors are now much more informed. Hence it is clear that Pay vs performance helps in growth of a company even from the interest of its Shareholders.