How to compensate the executives?

Executive Compensation

 

Over past decade the debate regarding executive compensation has taken a centre stage with people against the existing system arguing that the goals of the owners of the company (its shareholders) and those of the managers should be congruent in nature. This argument in turn has led to broader implications upon the methodology used behind the executive compensation by many corporate. Traditionally used stock options came under wide scrutiny for their implicit nature of not expensing the same from earnings after the accounting scandals were unearthed. Since, then companies have been forced to become more transparent in how they represent the compensations on their income statements. Many of the companies revisited their strategy of using equity compensation. Thereafter many companies went for other alternative which enabled them to help reduce the stockholder’s equity dilution. However, it’s a point of consideration whether those alternatives have really served to the best of the interest of the stockholders overall. Many of these alternatives tended to compromise the basic intention of enhancing the value for the company’s shareholders. The companies thus far have been in dilemma of choosing between the shareholders and the employee retention.

 

The companies across the US and the rest of the world have more or less failed to establish the link between the performance and reward. With the spectacular downfall of the capital markets across the world during the second half of last year the gravity of the “reward for performance” issue came into broad daylight. Many of the companies went bankrupt or are at the brink of facing one. However, the top executives of the companies have not had to face any heat at all and it’s all turned onto the common shareholders with the executive continuing drawing their hefty pay-cheques from the shareholder’s pocket. The single most important aspect from any shareholder’s perspective is the appreciation in the stock value through the means of performance of the company they invest in. Stock options, although very popular with the employees; don’t perform too well on this aspect as irrespective of the company’s performance over a period of time the employees get their share of the options. Restricted stocks are absolute giveaways when considered under this parameter alone. Under such challenging conditions, it’s about time now for the companies to consider the use of Indexed options as the means to compensate executives as opposed to their traditional counterparts. This will surely form the much required linkage between reward and performance by compensating employees only for their performance and not for non-performance.

 

The Indexed option as opposed to the stock option will be granted only when the company outperforms a pre-decided index (e.g. S & P 500) ensuring that the goal of the shareholders and the managers are aligned. The argument against the use of Indexed option could be that the challenge it poses in terms of retention of the employees. The cost to the company in case the key people leave the organization could be much higher than the expense it makes for retaining them. However, this alternative is still better than a “performance share” which is awarded sheerly on basis of the company’s performance and not the comparative performance. The managers will be better off being rated on a relative basis than sheerly against performing on the pre-set targets. The Indexed option thus is that “In between” alternative which could help companies in their dilemma of weighing among shareholder’s interest and the employee retention.