Executive compensation together with corporate governance systems has received an increasing amount of attention- from the press, corporations, financial academics and also the government. An executive compensation plan is a major application of the agency theory study and, thus, an agency contract between the shareholders and CEO’s of the business, which attempt to align the interests of the owners and the managers by basing the CEO’s or executive’s compensation on some performance measure of the managers expended effort in operating the organization. Over the last decade scandals such as the Enron and WorldCom have raised many issues and discussion as what went wrong? How did CEO’s walk out with so much money” and are executives overpaid and greedy?
Executive compensation plans are present in our daily work lives since they set “parameters” for compensation for executive remuneration. Most plans usually encompass net income and share prices; some plans only include net income. The most common forms of compensation are bonus, shares, salary, and stock options.
This papers focus is on the effects of performance measures in motivating manager interests. The incentive plan involves a mix of incentive, risk and decision horizon considerations. Executive compensation plans are important to accountants. Because they introduce a second major role of financial report: the role to motivate and monitor manager effort. If net income is informative and reflective of manager effort it improves the operation of the managerial labour markets and motivates productivity. Our main focus are addressed below:
Theory of executive compensation
-Discuss compensation committees
-Sensitivity to earnings and share price
-Are they necessary?
-Discuss no and yes for necessary
-How do incentive plans align interests of manager with shareholders?
-Provide example of incentive contract
Role of Risk in Compensation
-How do we control risk?
-Describe types of risk
-Describe effects of too much risk
-Describe effects of too little risk
Politics of Executive Compensation
-Attracts political controversy
-Are executives overpaid relative to firm performance?
-Regulation of increased disclosure of executive compensation
Compensation committees are a corporate governance device whose intention is to design a compensation program that attracts, retains and motivates managers and senior executives. It also designs a plan that delivers an efficient combination of sensitivity to earnings and share price, the precision of measuring earnings and share price, the decision horizon timeframe that the manager is responsible for and the risk regarding compensation to the company and the manger.
The composition of the compensation committee needs to be made up of individuals who are not affiliated with the company in order to be objective in it’s planning of the compensation. An example of a compensation committee is included in the Bank of Montreal’s Report on Executive Compensation as outlined below:
“A majority of the members of the Committee are resident Canadians who are not affiliated with the Bank for purposes of the Bank Act (Canada). Each member of the committee is not an officer or employee of the Bank or an affiliate of the Bank; and is “independent” within the meaning of applicable Canadian securities laws and New York Stock Exchange rules.”
Once the committee has been established, then the task of creating an effective compensation plan begins. Compensation plans are generally based on either net income or share price, but a truly effective compensation plan is devised using both net income and share price.
If net income of the company has high precision of information and a great deal of sensitivity to...