CEO pay at the crossroads of Wall Street and Main: Toward the strategic design of executive compensation.
1) My understanding of the paper:
Executive compensation has generated controversy related between the executive pay and the firm performance.
The lack of relationship has led to calls from for reform from various organizations (stakeholders, shareholders, etc.)
Linking compensation to objectives and performance measures emphasises short term profitability at the expense of the long term viability.
The base of evaluation market v/s accounting might be different in the way of evaluating performance strategically.
Combined ownership and control the incentive is not a threat because the manager is at the same time the owner. The principle of profit maximization is assumed to be sufficient to motivate and guide managers.
The separation of ownership and control are resumed in that the professional managers hold a small or in some cases none of the firm’s equity.
Pay for performance is a double edged sword, it has been found that CEO wealth changes $3.25 for every $1.000 in shareholders wealth. The level of executive’s compensation is driven by firm size than by performance.
The governance problems will result in compensations based in high fixed salaries.
Performance based strategy will be based in accounting incentives and stock market incentive, both have been criticized for the emphasis on the short term and the effect on the decision horizons.
The use of balance scorecard that adds alternative criteria to evaluate has been used lately, the problem is the difficult and cost to use this system.
Accounting based compensation:
The problem with accounting is that it reflects the past and not the impact on future decision, so using accounting is only effective in firms where the cash flow tends to be stable. Accounting is also useful where cost containments and operational efficiency are crucial.
Also the reason that accounting returns are allocable to lines of business they might be useful in diversified or multi-business firms.
Accounting will be useful in companies that pursue the following strategies:
- cost leadership strategies
- slow and standard cycle resource profiles (protected by patents, regulations, or mass production technology, etc.)
- unrelated diversification strategies (the use of intense financial control)
- highly leveraged capital structures
Stock market based compensation:
They generate a managerial myopia due to the pressure of the investors and other in the decision-making.
If investment in R&D will reflect in share price then the utilization of stock market incentives can be used.
Using market-based incentives is useful when the following strategies are used:
- differentiation (competitive advantage by charging a premium price)
- fast cycle resource profile (rapid technological changes and innovation)
- high growth industries (rapid demand driven growth)
- related diversification strategies ((business units that operate in similar industries)
- restructuring strategies (spin offs)
Differed compensation and firm strategies:
This is basically tomorrow payoff for today’s performance. It has advantages hat it postpones the payment of taxes. They postpone income during the initial stages for a increase as there carers progress.
Stock operation serves as an [next page]