The General Perception of CEO Compensation Finance Essay

Its general perception that CEOs compensation is very high and in recent years significant attention has been given to rising pay level of chief executive officer. Lot of researches has been done to explore the determinants of executive compensation. In most of studies positive relation between pay and performance has been investigated. Shareholder desire maximization of their wealth and wish that the board of directors should design compensation system which motives senior executives to make policies that maximizes shareholders wealth. Stockholders returns are closely associated with accounting profitability in long run, so usually compensation system depends upon maximizing accounting profits. In most large companies managers are not owners, they are support to work in away that in the best interest of the shareholders who are owners. Agency theory argues that executives only goal is not the same as of wealth .executives other may include control, power and increase in their compensation level. In order to achieve their other goals they might avoid attractive but risky investments because they worried more about their safety of jobs than healthier and attractive profit. These problems arise because managers who are hired as agent of principals (owners) have their personal interest. Theses conflicts between principals and agents are called agency problems.

1.1 THE COMPONENTS OF CEO PAY

1.1.1 Base Salaries

Base salary is the standard yearly pay of the executive. Base salaries for chief executive officers are usually pre calculated through competitive benchmarking, even though job evaluation is also used to determine executive pay in organizations as well. Normally executive's base salaries are frequently influenced by the judgment of the compensation committee consisting company's board of directors. The committee actually analyzes the gathered information from salary surveys usually from same or similar industry and then reach a conclusion to set the executive compensation. There can also be some other factors while determining executive compensation such as size of the organization in terms of employees, assets and revenues and whether the company is making healthier profits or going into losses.

1.1.2 Annual Bonus Plans

Annual bonus plan is a variable pay usually fluctuating and tied to the performance of the organization. The main objective of executive bonus compensation is to motivate senior executives in order to get maximization of shareholders wealth, which is ultimately the main goal of organizations. Shareholders are basically owners and investors of the company but they not participate in management and day to day operations. Executives are decision makers of the operations of the firm hence they manage the business on the behalf of shareholders and get their remuneration and reward for their expertise and services they provide to the firm. According to agency theory executives only goal is not the same as of the shareholders that is the maximization of the wealth of shareholders; their other goals include power, Control ad increase in their personal compensation. Therefore, to bend the executive's motive and decision making in the best favor of share holders, some flavor of bonus component in added to executive's compensative. Given below are five basic types of executive bonus compensation plans.

1.1.2.1 Stock Options

Stock Options provide the executive with the right to buy company stock at a fixed price at some future date. Compensative is determined by difference between exercise price and option price of the stock (Initial and selling price of the stock).It means an executive will only be able to receive the bonus in the case when share prices increase. If the share price goes down than the option price, then the options become valueless. The shortcoming of the stock options is that rise and fall in share prices do not explain all dimensions of executive's performance .It is not widely practiced in Pakistan.

1.1.2.2 Restricted Stocks

The rational of the restricted stock is to promote longer executive tenure. In restricted stock executives or employees are given certain number of company share and they are prohibited from selling those shares for a period pre defined, it means they cannot sell those shares before a certain defined time period. If an employee or executive having restricted stock leaves the company on his own wish before date pre defined date the shares are forfeited. That's how the restricted stocks are used to promote the longer tenure of executives, which is ultimately beneficial for the firm and shareholders in the sense that there will be consistency in the strategies and policies and executives remain with the firm for the longer period of time. The shortcoming of the restricted stock is that there is no downside risk to executive who always get profits like other shareholders.

1.1.2.3 Golden Handcuffs

Golden handcuffs can be either a restricted stock in which the stock compensation is delayed until resting time provisions are fulfilled or to a bonus income that is series of annual or semi annul installments . It may also involve paying an executive any amount at the retirement time or any other predefined age. Compensation is forfeited in a case where executive resigns or is fired before time. The rational of golden handcuffs is to offer an incentive to executive to keep him with the firm. Short coming of this bonus plan is that it may promote risk a verse decision making due to downside risk borne by executive. Executives are considered to be valuable by the firms and most of the firms take great care of them. Executives are very much aware and use to cost cutting techniques and existing strategies that are formulated by them. When executives and changed, new comers bring in a lot of discontinuity in current strategy .Thus golden handcuffs are congruent with long term strategies plans. Firms may adopt golden handcuffs when stability of executives or management is crucial to firm's growth.

1.1.2.4 Golden Parachutes

The rationale of golden parachutes is to talented executives with the firm. Golden parachutes involves compensative an executive with substantial amount if he retires, is fired or quiets the job. It means executive have right to get the bonus if they loose their position due to resignation, retirement firing or takeover. The shortcoming of the golden parachute is that it is rewarded regarded regardless of success or failure that means whether the wealth is created for shareholders or not. The difference between golden handcuff is paid in series of annual installments while in the case of golden parachute payment of bonus is made at the time of retirement, firing, takeovers or resignation.

1.1.2.5 Cash

It's the type of bonus compensation paid in cash usually quarterly or annually based on accounting performance measures such as return on assets, earning per share, net income, return on equity. This type of bonus plan is introduced to offset limitation of market based measures of performance and to compensative on the basis of accounting measures of performance. There are some factors that are beyond the control of managements that causes firm's share prices low despite really good performance by executives. In the above cases deserving executives are not paid bonus compensation due to undervalued share price. So cash compensation plan corrects that issue by compensating an executive on the basis of internally measured performance. Lot of criticism has been made on compensating an executive on the basis of accounting measures as there are flaws in accounting system and argue that these figures do not represent actual managerial performance and they believe that compensation should be given on the basis of financial or market based measures which truly represents executives performance and maximizes share holders value

1.1.3 Executive Benefits and Perquisites

As there is a huge difference between pay level of executives and low level employees, same way benefits provided by company to executives also vary from those of lower level employees. Executives receive many benefits like life insurance, pension plans and health insurance. Executive's perquisites "Perks" are unique services and benefits provided by firms to executives. It includes membership in clubs; company maintained automobiles, executive dinning room special reserved parking, company aircraft use, physical exam, financial counseling, home security, sports tickets and many more.

1.2 WHO SETS CEO PAY

CEOs are the policy makers in the organizations. There is a question that if chief executive officers are leaders and head the organization who formulate rules and regulations then do they set their own pay level themselves and who decides that whether they should be given bonus or not, if yes then how much? If we go through the controversial issue of chief executive officer compensation we will come to know that there is a strong perception that chief executive officers sets their own salaries, but usually this is not the real case. Normally chief executive officers compensation is set outsiders (Board of directors) who are very much aware about the conflicts between stockholders and managers (executives) and luterests of both parties. But we san not reject the fact that top level executives exert some influence on Board of Directors in setting their compensation (Both Base Salary and Bonuses). Usually committee of two or more than two outside directories is formed to set the day level of CEOs in most of the countries. The committee conducts market studies in the same industry and set the pay level. Then those recommendations about pay level are sent to human resource department and top level manages for approval ad revision before being presented to Full Board of Directors to Final Approval.

1.3 STATEMENT OF THE PROBLEM

Considerable attention has been given to high and rising pay levels of chief executive officers. Critics argue that chief executive officers compensation is very high and it reduces the value creation of stock holders who are actual owners of the firm. They believe that compensation level should be accordance with the performance of the firm and senior executives pay level should be set in a way that motivates them to make strategies that are in the best interest of shareholders. So, there is a need of precise relationship between chief executive officers compensation and those variables that can play a significant role in determining the executive compensation. The variables used in this study and their justification have been discussed in greater detail in chapter 3.

1.4 OBJECTIVE

As mentioned above, abundant research has been carried out to find out the determinants of chief executive officers compensation but there is a lack of precise investigation to analyze the determinants of chief executive officers in Pakistan. In this way the objective of this study is to investigate or evaluate the relationship among the chief executive officers compensation, performance and size of the firm. For this purpose accounting based measures such as return on assets (ROA), return on equity (ROE), Income before tax etc will be used as predictors while CEO compensation (Both cash and non cash) will be used as dependent variable to find out the impact of predictors on CEO compensation in Banking industry of Pakistan.

1.5 RESEARCH SCOPE/LIMITATIONS

The scope of this study is to analyze impact of size and performance of the firm on chief executive officers compensation. Few limitations of this study has been given below. This research would just restrict to secondary data and no primary data will be used. The access of data would be restricted to public information and all organizations do not share their information. As data is collected from annual repots so annual reports are only available for last few years (Normally 4-5 years) on the websites of the organizations.

1.6 THESIS STRUCTURE

The report is systematized as follows. Chapter (1) contains introduction of the thesis, which includes the statement of problem, scope and limitations, objective and some of the theoretical perspective regarding the executive compensation. In chapter 2 relevant literatures would be discussed. In chapter (3) methodology will be described that constitutes the data and justify the choice of the variables used in our analysis sample, technique and also estimate model used in analysis. In chapter (4) results would be analyzed after the data processing. Chapter (5) will conclude the thesis and will contain discussion and recommendations.

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