Executive Incentive Schemes: an Analysis of Their Influence on Corporate Performance

Topics: Corporate governance, Stock market, Chief executive officer Pages: 10 (2429 words) Published: October 23, 2008

Most business environments are complex - with intensive competitive activity (including newcomers) and high stakeholder expectations.

Thus ongoing improvements in corporate performance (including better resource allocation and asset utilisation) become critical factors for company profitability and sustainability of their business models.

Consequently, many directors are getting substantial rewards in the form of monetary-based incentive schemes as personal rewards for driving their direct-reports to pre-determined target performance levels.

This however poses a question; what relationships exist between these schemes and ultimate organizational performance achieved in a reference period?

Financial measures may be used to measure the performance achieved of a given company after the implementation of a successful executive incentive scheme.
From such an analysis, a positive relationship may be proved to exist, but other factors could also strongly influence the performance of a company.

Thus we should establish some fundamental rules for the design of incentive schemes.

Rule number one:
Rewards should not encourage dysfunctional behavior by individual executives

Such as maximising financial benefits largely for themselves (a fundamental prerequisite of performance related pay).

Rule number two:
Incentive schemes should be fully aligned with time-related and agreed corporate strategic objectives Some of which may be soft issues –such as changing a corporate culture to make it more ‘entrepreneurial’.

There is strong evidence in the literature to indicate that an organisation’s behaviour will change if the way performance is measured!

Conclusion: what gets measured gets done

Thus to ensure that executives do have the overarching interest of shareholders as their primary motive, they should be ‘incentivised’ with some sound control limits over their decision-making powers.

Such controls should not have a detrimental effect on the advantages that can arise from a high level of decentralized autonomy in the hands of competent and ethical management teams.

Literature Review (some research findings)
Covas (2004) found that Chief Executive Officers (CEOs) with high sensitivity to movements in share prices tend to deliver lower performance for the firm, as they are likely to be more risk averse in their dealings.

Covas concluded that ICSs should be made with reference to business cycles.

Also studies by Jensen and Murphy (1990), Hall and Liebman (1998) and Murphy (1999) show that pay-performance sensitivities have increased considerably within the past decade (cited by Covas, 2004).

In 2003 some poor performers were punished.

For example, Silicon Graphics Inc., which lost $129.7 million, had its CEO, Robert R. Bishop forgo both his bonus of $370,000 and his 750,000 share option (Lavelle and Arndt, 2004).

An incentive can be said to be a reward with an objective of inducing an action. It may be financial or non-financial.

The former includes cash incentives and annual bonuses, while non-financial ones could include such things as promotion and greater autonomy.

Incentives tend to have a higher chance of positive motivation if they are linked to individual performance.
However in developing ICSs care has to be taken to ensure that too little or too much is not given to the recipients.

It will be too little if it is not enough to induce a positive action (Smith, I. 1991).

The use of a fixed remuneration might provide an incentive to perform well for a while, however in the long-run, it may results in ‘managerial shirking’ since they know that their remuneration package is not mainly determined by their level of performance.

Therefore the regular revision of an ICS could make them more beneficial to...
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