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Executive Compensation

Executive Compensation – Chief Executive Officers (CEOs) of public companies are routinely perceived to be overpaid and their boards are perceived to provide poor or limited oversight. These perceptions have three typical components:(1) CEOs are overpaid and their pay keeps increasing; (2) CEOs are not paid for performance; and (3) boards are not doing their jobs as monitors. Shareholders and boards of directors who cannot easily monitor the actions of their executives should use stronger incentives to align the executives’ incentives, but the same inability to monitor coupled with the stronger incentives creates greater opportunities and incentives for the executives to commit fraud.

Executive Compensation

When hiring a top class executive, the executive compensation is considered to be of much importance, to both the executive as well as the company. The task of finding and hiring an executive who would prove to be an asset to the company is a challenging one. The executive compensation offered by the company helps to attract the best candidate at all top executive levels and to retain them further.

The basic salary is a definite component and the other components may vary depending upon the company policies. It is very useful to have some knowledge about these components of CEO compensation to proceed further. So these components are briefly explained as under:

  1. Base Salary
  2. Annual Bonus
  3. Restricted Stock
  4. Non-equity incentive plan
  5. Stock grants
  6. Stock appreciation rights
  7. Pension and deferred compensation

The objective of present study is to increase our knowledge of executive compensation practices through an analysis of specific factors of executive compensation in Pakistan like firm size, firm performance and corporate governance arrangements. These determinants already researched and identified significant impacts on executive compensation practices in prior empirical research but most of the studies have conducted in developed countries. So there is still need of research on this topic for developing and emerging countries like Pakistan. In Pakistan corporations are historically family-controlled, particularly those in the textile, automotive, tobacco, and agricultural sectors. There are three main types of listed corporations in Pakistan, multinational, family-controlled and state-owned enterprises. A majority of listed corporations are family-controlled via pyramid structures and cross shareholdings. Observations suggest that the presence of equity-based compensation is not associated with fraud. An open question, however, is whether the size or strength of the incentives provided by equity-based compensation affects the likelihood of choosing to commit fraud.

The main problem with measuring the effects of compensation is one of identification. Compensation arrangements are the endogenous outcome of a complex process involving the CEO, the compensation committee, the full board of directors, compensation consultants, and the managerial labor market. As a result, compensation arrangements are correlated with a large number of observable and unobservable This makes it extremely difficult to interpret any observed correlation between executive pay and firm outcomes as evidence of a causal relationship. For example, CEO pay and firm performance may be correlated because compensation affects performance, because firm performance affects pay, or because an unobserved firm or CEO characteristic affects both variables.

We also compare stock and operating performance measures for fraud and control firms. Stock returns over the years of the fraud do not differ significantly across fraud and control firms. However, stock price declines approximately twenty percent for fraud firms on the first disclosure of potential fraud.

These results imply that but for the deceptions; the fake firms would have significantly under performed their matched control firms. Both the fraud firms and control firms have significantly negative market adjusted returns during the fraud periods.

Measuring the incentive effects of CEO compensation has been a central goal of the literature since at least the 1950s. Early studies focused on identifying the measure of firm scale or performance (e.g., sales, profits, or market capitalization) that best explains differences in the level of pay across firms.

The next generation of studies tried to quantify managerial incentives by relating changes in executive pay to stock price performance. Although these studies found the predicted positive relationship between executive compensation and shareholder returns, they systematically underestimated the level of incentives by focusing on current pay.

Subsequent studies have examined how different aspects of executives’ equity incentives relate to firm value, with mixed results. For example, Mehran (1995) finds that firm value is positively related to managers’ fractional stock ownership and to the fraction of equity‐based pay. Habib & Ljungqvist (2005) observe a positive association of firm value with CEO stock holdings, but a negative one with option holdings. Many other studies fail to find any relationship between firm value and executives’ equity stakes

The “right” measure of CEO incentives has been the subject of a long debate in the academic literature. The correct measure of incentives depends on how CEO behavior affects firm value. In a modified agency model that allows the marginal product of CEO actions to vary with the value (or size) of the firm, the level of CEO incentives depends on the type of CEO activity considered.

Determining whether observed compensation contracts optimally address the moral hazard problem between shareholders and CEOs is difficult. The optimal incentive strength depends on parameters that are not absorb-able, such as the marginal product of CEO effort, the CEO’s risk aversion, the CEO’s cost of effort, and the CEO’s outside wealth. The rent extraction view posits that weak corporate governance and acquiescent boards allow CEOs to (at least partly) determine their own pay, resulting in inefficiently high levels of compensation.

Market‐based explanation for the growth in CEO pay is a shift in the type of skills demanded by firms from firm‐specific to general managerial skills. Such a shift intensifies the competition for talent, improves the outside options of executives, and allows managers to capture a larger fraction of their firms’ rents.

The debate about the nature of the pay‐setting process and the recent financial crisis has created renewed interest in the effects of compensation on CEO behavior and firm performance. Most concerns about managerial pay would be alleviated if high levels of CEO pay and high wealth‐performance sensitivities led to better performance and higher firm values. However, providing convincing evidence on the effects of executive pay is extraordinarily difficult.

The main problem with measuring the effects of compensation is one of identification. Compensation arrangements are the endogenous outcome of a complex process involving the CEO, the compensation committee, the full board of directors, compensation consultants, and the managerial labor market. The bulk of the literature on CEO compensation has documented that, after moderate rates of growth in the 1970s, CEO pay rose much faster in the most recent decades. Using extreme value theory, they calibrate the distribution for a manager’s talent and combine this with a calibration of the size distribution of firms.

In an influential paper, Jensen and Murphy (1990a) point out the seemingly low sensitivity of executive pay to performance: an increase in total wealth of $3.25 for each $1,000 of increase in the firm value. This measure of sensitivity is, in the data, highly negatively correlated with the size of the firm.

Executive Compensation – Conclusion:

As the trend of companies is changes from international to multinational there is need to set the standards of the executive compensations. In the companies that are company based there are many problems because the executives are not compensated as the rules and regulations and according to the theories. But the role is changing with the passage of time. In the developing countries the executive compensation is considered, and they got the things that are promised too them in result they give increase in the performance of the companies by acting in an impressive way. Install new technology and work for the company not for the self-interest. Many theories tells about the executive compensation and the related problems that are agency theory, managerial power theory.

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