Welcome back to our Corporate Governance Weekly Blog! In this edition, we’ll be delving into the intriguing world of executive compensation and incentives, exploring the complexities, real-life examples, and guidelines for best practices.
CEO pay has skyrocketed 1,460% since 1978. CEOs are paid 400 times as much as a typical worker based on a 2021 survey. In 2021, we project that a CEO at one of the top 350 firms in the U.S. was paid $27.8 million on average (using a “realized” measure of CEO pay that counts stock awards when vested and stock options when cashed in and ownership is taken). This 11.1% increase from 2020 occurred because of rapid growth in vested stock awards.
Understanding Executive Compensation
Executive compensation refers to the financial and non-financial rewards given to top executives, such as CEOs, CFOs, and other C-suite officers. It plays a critical role in attracting and retaining top talent, motivating executives to perform at their best, and aligning their interests with the long-term success of the company.
Breakdown of Executive Compensation
Performance Bonuses: Many companies offer performance-based bonuses tied to specific financial and operational goals. For example, if a company achieves a certain level of revenue growth or profit margin, the CEO may receive a bonus as an incentive for their contribution to the company’s success.
Equity-Based Incentives: Stock options, restricted stock units (RSUs), and performance shares are common equity-based incentives. These align the executives’ interests with those of shareholders since their compensation is directly tied to the company’s stock performance.
Golden Parachutes: In some cases, executives may be offered “golden parachutes” – lucrative severance packages in the event of their termination due to a change in control of the company. While these are intended to provide executives with financial security, they can also be a source of controversy and shareholder concern.
Guidelines for Best Practices in Executive Compensation
To ensure a fair and effective executive compensation program, companies should follow these best practices:
- Link to Performance: Compensation should be directly tied to measurable performance metrics, encouraging executives to work towards achieving the company’s strategic objectives.
- Balance Short-Term and Long-Term Incentives: A mix of short-term and long-term incentives helps promote both immediate results and sustained growth over time.
- Avoid Excessive Risk-Taking: Compensation plans should not incentivize excessive risk-taking that could harm the company in the long run. Clawback provisions can help recover excessive payments if necessary.
- Transparency and Disclosure: Companies should disclose executive compensation details to shareholders and the public, promoting transparency and accountability.
- Independence of Compensation Committees: Compensation decisions should be made by independent directors on the compensation committee to avoid conflicts of interest.
- Benchmarking: Compensation committees should compare executive pay with similar companies in the industry to ensure competitiveness and alignment with market standards.
An iconic example of modest executive compensation is Warren Buffett, the Chairman and CEO of Berkshire Hathaway. Despite leading one of the world’s most successful companies, Buffett has consistently taken an annual salary of just $100,000. His wealth comes primarily from his substantial ownership stake in Berkshire Hathaway, aligning his interests directly with shareholders.
Recommendation
Recommendation would be to enact policy solutions that would both reduce incentives for CEOs/Board members to extract economic concessions and limit their ability to do so. Such policies could include reinstating higher marginal income tax rates at the very top; setting corporate tax rates higher for firms that have higher ratios of CEO-to-worker compensation; using antitrust enforcement and regulation to restrain the excessive market power of firms—and by extension of CEOs; and allowing greater use of “say on pay,” which allows a firm’s shareholders to vote on top executives’ compensation.
List of Highest Paid CEOs
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