Executive compensation has spiraled up in the last couple of decades, many observes that top management benefiting themselves at the expense of shareholders. The business corporation is carried and organized on primarily for the profit of the stockholder. Therefore director's power is to be focus on the interest of stockholder. (Bebchuk L et.al, MA: Harvard University). Executive compensation scheme is a reward to the top executive that paid by the Business Corporation in the organization. This top executive are included the company president, Chief Executive Officer(CEO), Chief Financial Officer(CFO), and also other upper-level managers. Top executive use their influence to get higher compensation through arrangement that have substantially decoupled pay from performance. Top executive such as CEO's, CFO's are under the fiduciary duty to maximize the shareholder wealth but they set high compensation by their own. (Bebchuk L et.al, MA: Harvard University) .Public attention has captured wide spread of the level of compensation received by the top executive, most of it from a general fascination with the large sum of money involved. If ownership and managerial interest are perfectly aligned, the intention of the top executive of the company can be maximize the shareholder wealth. (Main B, University of St Andrews, UK). Evaluating and rewarding executive performance is a responsibility of board of directors as representatives of the corporation shareholders. (Kerr J et.al, Southern Methodist University). Jeffery Kerr states that maximization of the economics value of shareholder investment is the main purpose of both corporation's management and its board. (Kerr J et.al, Southern Methodist University).
Lucian Bebchuk say that executive and shareholder interest cause to diverge by the executive compensation that failed to provide executive with proper incentives, therefore the Arm's length Bargaining Model of executive compensation or it also called as principal- agent problem was use by Lucian Bebchuk. One of the classic principal-agent problems is corporate management; it is the problem to the separation of ownership and control in public corporation. (Bebchuk L et.al, MA: Harvard University).
Capital Asset Pricing Model (CAPM) is a useful way of viewing shareholder wealth. If shareholders interest and managerial objectives as align than top executives pay is influenced by performance indicator. (Main B, University of St Andrews, UK). Brian say that, the distinction is made between the level of performance relative to the market(the normal return) and the level of performance that is over and above this reference level( the abnormal return). (Main B, University of St Andrews, UK). In contrast, Lucian Bebchuk say that, the most important compensation that tried to performance is cash compensation but the important tools for incentivizing mid-level manager is the bonuses and other accounting based compensation schemes, because there are limited contribution in certain area of the organization and the firm for the mid-level manager.(Bebchuk L et.al, MA: Harvard University).
Shareholder can be described from the normal return and abnormal return. Normal return captures the cash-equivalent increase in shareholder wealth that have resulted that performed in stock to the market as was indication by its historical performance. Actual return exceeded of fell short of this amount is representing by abnormal return. (Main B, University of St Andrews, UK). Brian state that shareholder return is labeled as normal return and it measure the expected return to shareholders. Because the larger rate of compensation for normal return can be viewed as a more retrospective component of remuneration, as it rewards the executives for the return that shareholder have come to expect given the recent performance of the company. Abnormal return, which depends on the company performance, is remaining as weaker link to the shareholder return. Although top executive pay link in a significant way to shareholders interest. (Main B, University of St Andrews, UK). Abnormal returns are the consideration of board in their evaluating CEO's performance. (Kerr J et.al, Southern Methodist University).
As stated by Lucian Bebchuk, executive compensation can be grouped by three basic categories. The first is salary and benefit that is not depends on the firm performance. The second is that option and other incentive compensation that are based on the firm stock price performance and the third is the bonuses and other incentives compensation that are based on the firms performance according to specified accounting metrics. (Bebchuk L et.al, MA: Harvard University). He also state that the lack incentives that align manager and shareholder interest is salary and other non-performance based compensation. To reduce the risk, managers compensate with fixed claim on the corporations assets because they will value preservation of assets more than creating new wealth. (Bebchuk L et.al, MA: Harvard University). In contrast Jeffry Kerr says that firm stock performance will not be a consideration by the board of director when changing salaries and bonuses of CEO's. Overall market movements of abnormal return are associated with adjustment in compensation. Therefore evaluating and rewarding executive by board is not on the basis of stock price, because board view stock price as a short-term and it is inadequate measurement of firm's long-term health. (Kerr J et.al, Southern Methodist University). Therefore Jeffry Kerr state that compensation is not used as rewards for a stock performance. The logical basic for executive compensation must provided by variation is shareholder return, because the executive are paid on the basis of organizational size. (Kerr J et.al, Southern Methodist University).
James says that, the share option schemes can confer windfall gains which are not grounded in any real improvement in company performance. Therefore James says that the share option schemes for executive should not be granted in large block, perhaps it should be based over a period of time. In addition James State that share option should not be granted at a discounted price at the time of issue. Long-term incentives schemes other than share option might be more effective in ensuring that the reward are linked to performance and it also encourage the directors to build up shareholding . (Hughes J). in contrast, Jeffery Kerr say that stock option is an important for executives compensation but there is no theoretically and empirically appropriate method of evaluating it. Stock options provide incentive for future result; because future interest of a CEO's is to increase in the wealth of shareholder and this is align with long-term incentives like stock option. This stock option normally use ex ante measures. (Kerr J et.al, Southern Methodist University).
Martin measures compensation in term of incentive compensation, which represents the value of long-term incentives award made during the year, for example share option or shares allocated under the long-term incentives plan. (Conyon M et.al). These long-term incentives plans are calculated as the company share price multiplied by the maximum potential number of shares that can be received as a result. (Conyon M et.al). but Brian say that the size of company can be determine the pay of top executives by measuring its revenue, assets or number of employees as an indication of managerial responsibility, some more workload also has an influence on pay to top executives. (Main B, University of St Andrews, UK).
Aleksander says that New Zealand government has revised Companies Act, under this New Zealand has given time until 1 July 1997 to reregister their company. The reregister required the New Zealand firm to disclosure the cash and non cash compensation of all executives' earnings that excess of NZ$100,000. (Andjelkovic A et.al). Aleksander say that from his sample of 49 firm that listed in New Zealand exchanges and find there is no significant relationship between the compensation paid to New Zealand CEO's and the stock market performance of the firms they serve and also there is no relationship between the level of CEO's pay and performance. He fined that executives pay depends on firm size, but remuneration paid to New Zealand CEO's is based on the firm performance. (Andjelkovic A et.al).
In June 2002, a new listing standard has been approved by the New York Stock Exchange's board that among other thing significantly enlarged the role and power of independent member of listed companies' board of directors. In month of July of the same year President Bush signed into law the ‘Public company Accounting Reform and Investor Protection Act of 2002(The Sarbanes Oxley Act)' which he praised for making ‘the most far-reaching reform of American business practice since the time of Franking Delano Roosevelt'. Bebchuk and Fried indentified a number of those reform speak directly to the sources of management power. Compensation committee must be created by listed company under the new listing standard of New York Stock Exchange, it comprised solely of CEO's. [Bebchuk L et.al, MA: Harvard University].
The compensation committee that created by listed company under New York Stock Exchange new listing standard, is now charged with hiring compensation consultants, a task previously left to management. To address the longstanding problem of directors interlock, in which CEO's of two companies would sit on each other's compensation committee and presumably scratch each other's back, the new listing standard provide that a directors may not be deemed independent if he is employed or has been employed in the last three years by a company in which an executive officer of the listed company serves as a member of the compensation committee. [Bebchuk L et.al, MA: Harvard University]. Lucian Bebchuk state that, New York Stock Exchange standard also address a cornerstone element of managerial power model, the CEO's has influence over the selection, reappointment, and compensation of directors.
The new listing standard provides that directors may not be independent if he is employed by a company in which an executive officer of the listed company serves as a member of the compensation committee. And Lucian Bebchuk state that these requirements must comply in all public corporation. (Bebchuk L et.al, MA: Harvard University).
Directors share ownership aligns with the board interest with those of outside stockholder. Directors may maximize their own utility of the expense of outside stockholder if shares owned by directors are greater and more sheltered they are from potential corporate control. Therefore is become weak in motivating and incentives to discipline executive compensation. (Andjelkovic A et.al).
James has state that all public companies should establish a remuneration committee, and remuneration committee's responsibilities are on the determination of companywide policy on remuneration such as individual remuneration package for each executive directors and other senior executive and finally remuneration committee is responsible to report the matter relating to executive remuneration to the shareholders. (Hughes J). There are three elements in executive remuneration package; the first is the size of basic pay increase. Second is the gain from share option and the third is compensation payment to the directors on loss of office. Large companies should have three or more member of the remuneration committee and it must confirm to non-executives directors because they have no direct personal financial interest. James says there there cannot have independent member from outside of the company in remuneration committee, because remuneration committee need take fairly knowledgeable about all aspect of the company. (Hughes J). Jeffery Kerr state that board ignore their responsibility to shareholders and increase compensation to CEO's regardless of a stock's performance, but other compensation of reward system tie an executive interest to shareholder, therefore correlation between annual compensation and stock performance is not critical. He also state that poor corporate performance will damage the reputation of CEO's
Organizational structure of a company may play a role in determining the pay of top executive, such as at the board level may be indicate the pressures on top executive pay. Management who arrange for self-serving of high salary payment can be reduced by large number of outside or non-executive directors on the board. Because they are relatively have strong degree of owner control. (Main B, University of St Andrews, UK). The board of directors is at the hearts of corporate governance as shareholder have give authority to the board to oversee and control decision made by management, CEO's have more influence over the board. If CEO has duality position in firm, than there will be increase in decision power of the CEO's. These decisions are made to benefit the management to the determination of shareholder. Therefore CEO duality negatively affects acquisition performance. Nina state that the chairperson led the board of directors, if the CEO filled the role of chairperson it place them in a powerful position of managing the operation of the firm and also overseeing the direction of the company will take in the future. As a chairperson, the CEO is responsible for running the board meeting, sitting agendas and overseeing the process of hiring, firing and compensating to top management. (Dorata et.al). Martin says that group of agent who competes for a fixed prize and rewarded on their relative performance are consider as tournament theory, an application of tournament theory is the competition to become CEO. The tournament model predict that if there are many job position within a company, there will be an increase compensation gap as individual move up the hierarchical ladder. (Conyon M et.al).
Interest of Shareholder and manager may diverge in three particular ways that indentify by Lucian Bebchuk. The first way is manager may shirk. Second is manager who makes significant non diversifiable investment in firm and hold an undiversified investment portfolio. In which equity of their employer is substantially over-represented will seek for minimize firm specific risk that shareholder eliminate through diversification. As a result, managers generally are more risk averse than shareholder would prefer. Third, manager claim on the corporation are limited to their tenure with the firm, while shareholder claim have on indefinite life. Therefore manager and shareholders will value cash flow using different time horizon in particular manager will place a low value on cash flow likely to be received after their tenure period end. Shareholder, who is also the owner of the firm, has no control over firm day-to-day operation or long-term policy of the firm because it control by the professional manager of the firm. (Bebchuk L et.al, MA: Harvard University).
Lucian Bebchuk argue that compensation schemes are to be the product of Arm's length Bargaining between manager and shareholder, because manager attempting to get the benefit for themselves, and shareholder seeking the board to get the best possible deal for them. Arm's length Bargaining models used by financial and assume compensation schemes are generally efficient, while court generally defer the decision by the board. (Bebchuk L et.al, MA: Harvard University). Alexsandar argue that there is a positive significant on pay-performance of firm that reregisters under the revised Companies Act of New Zealand in his example. He also state that executive performance can be measured by the firm stock return for the year prior to that in which compensation is received. (Andjelkovic A et.al).
CEO duality may provide a rich opportunity to make sub-optimal decision because of low monitoring effect. CEO and management will benefit from mergers and acquisition and therefore shareholder lose because of they have to pay for the benefit to the acquiring CEO's. CEO with dual position will benefit personally regardless of firm performance because they are the only who authorize the merger/ acquisition decision. (Dorata N et.al)
Lucian Bebchuk claims that director's incentives to enhance Shareholder value are not generally sufficient to out weight the various factor that also induce board to favor executives. The nomination of directors are control by the board of directors, when the time to elect the director, the board nominates a slate, which is then put forward on the company proxy statement. The new SEC Rule 14a-11 states that shareholder can place their nominees on the company proxy statement and ballot. (Bebchuk L et.al, MA: Harvard University).
The number of executive director on the board may represent the number of executives who are competing in rank-order tournament for the top executive job. There will be higher pay to the top executive if number of executive on the board is large. (Main B, University of St Andrews, UK). Governance structure are important for executive for executive pay to constraining and discipline executive compensation and it will be more effective if board are more vulnerable to pressure imposed by stockholder and capital market. In large board, responsibility of each individual directors become lower and it may reduce scrutiny of executive pay, therefore small board is more efficient compare to the large board. (Andjelkovic A et.al).
Aleksander say that to monitor and discipline of the executive compensation become stronger if there is a few number of inside directors on board, because low proportion of inside directors is associated with superior performance. CEO's compensation is to be an increase function of firm size, because big firms confront CEO with greater and more complex operation and responsibilities compare to the small firms. (Andjelkovic A et.al). This statement is support by Martin by saying that CEO's enjoy a level of pay that is higher than those at the next reporting level down. (Conyon M et.al).
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