Evaluating Executive Compensation

Occasionally, you’ll see or hear some news reports decrying how much some CEO or another is paid. What the focus should be on, however, is how top executives are compensated. That is more illuminating than what the salaries are. With that said, here’s what you should know about evaluating executive compensation.

The Issue

Each year, a variety of media outlets publicize top CEO salaries, invariably followed by criticism from consumer activists, union types, politicians, and the public at large. The main problem is that while many people have a feel for “how much” top execs are paid, they are unaware of “how” they are compensated. Such a fundamental understanding can go a long way toward evaluating executive compensation.

Tradition and Executive Pay

Typically, how top executives are paid has relatively little to do with performance. According to a survey by the Harvard Business Review, for example, a $1,000 change in a company’s market value meant a change over two years of only $2.59 in salary and bonuses. Many people are surprised by this lack of linkage.

Bonuses Don’t Swing CEO Pay

About half of chief executives’ base pay is from bonuses. However, such bonuses don’t amount to significant fluctuations in chief executive officer pay. In fact, comparisons of execs’ yearly inflation-adjusted compensation changes with randomly chosen hourly and salaried employees illustrate very similar distributions. 

What Organizations Can Do Regarding Incentives to Maximize Organizational Value

Employers may want to consider some combination of the following policies to establish cash incentives for executive compensation:

• Mandate that top execs own plenty of organizational stock. Employers that control a good percentage of total corporate equity allow top managers to gain direct feedback from the employer’s market value.
• Consider structuring compensation, stock options, and bonuses in a way that will reward chief executives big time for exceptional performance and penalize them comparably for subpar performance. Establishing better incentives means hiking CEOs’ financial risk, which will benefit the organization in the long run. 
• Make sure CEOs know they can be terminated for poor performance. Such a threat can go a long way toward getting senior execs to maximize organizational value.

Monetary Rewards Still Matter

It is true that in general, it now takes more than a sweet paycheck to attract and retain talent. Employees are paying more attention to factors such as workplace culture and organizational perks. However, this phenomenon may be slightly less true for the individuals who head large companies. After all:

• It’s good to have the best available individuals head the companies the turn out the goods and services that are central to the nation’s economy.
• Surveys have found that most talented people would rather be rewarded according to performance instead of separate from it.
• The competition might pay more.

Still, Money Doesn’t Trump All

Having said the above, it’s also true that nonmonetary rewards such as public visibility, prestige, and power tend to generally matter greatly among CEOs. The key is creating pay programs that tie pay to performance.

The Problem with CEO Pay Lists

Remember those annual pay lists we talked about that are published by the business press? Note that they’re about compensation rather than performance. However, most such lists are accompanied by stories that discuss the performance of each company involved.

Ultimately, when it comes to evaluating executive compensation, your task is to find a balance between competition-beating pay and corporate accountability. Performance incentives are especially important here. For help establishing a compensation package for your organization, we recommend the leading global consultant Mercer for its vast experience, accreditation, and successful track record.