Chapter 5 Executive Remuneration and Incentives

Executive Remuneration:

Definition:

Executive compensation (also executive pay), is financial compensation received by an officer of

a firm. It is typically a mixture of salary, bonuses, shares of and/or call options on the company
stock, benefits, and perquisites, ideally configured to take into account government regulations,
tax law, the desires of the organization and the executive, and rewards for performance.

The three decades starting with the 1980s, saw a dramatic rise in executive pay relative to that of
an average worker's wage in the United States, and to a lesser extent in a number of other
countries. Observers differ as to whether this rise is a natural and beneficial result of competition
for scarce business talent that can add greatly to stockholder value in large companies, or a
socially harmful phenomenon brought about by social and political changes that have given
executives greater control over their own pay.

Executive pay is an important part of corporate governance, and is often determined by a

company's board of directors.

Meaning:
Executive compensation is how top executives of business corporations are paid.
The purpose of compensation of an executive is for an individual who is in a management
position at highest levels.
This category includes presidents, vice presidents, managing directors and general managers.

Features:
Managerial compensation cannot be compared to the wage and salary schemes meant for in
other employees in organizations.
Executives are denied the privilege of having unionized strength.
Secrecy is maintained in respect of executive compensation.
Executive pay is not supposed to be based individual performance rather on organizational
performance
Compensable Factors:
Job related experience.
Training time required.
Frequency of review of work.
Utilization of independent choice.
Frequency of reference to guidelines.
Frequency of work transferred through supervisor
Analytical complexity.
Time spent in processing information.

Types of Compensation:

There are six basic tools of compensation or remuneration:

salary
short-term incentives (STIs), sometimes known as bonuses
long-term incentive plans (LTIP)
employee benefits
paid expenses (perquisites)
insurance

In a modern corporation, the CEO and other top executives are often paid salary plus short-term
incentives or bonuses. This combination is referred to as Total Cash Compensation (TCC).
Short-term incentives usually are formula-driven and have some performance criteria attached
depending on the role of the executive. For example, the Sales Director's performance related
bonus may be based on incremental revenue growth turnover; a CEO's could be based on
incremental profitability and revenue growth.

Bonuses are after-the-fact (not formula driven) and often discretionary. Executives may also be
compensated with a mixture of cash and shares of the company which are almost always subject
to vesting restrictions (a long-term incentive). To be considered a long-term incentive the
measurement period must be in excess of one year (35 years is common).

The vesting term refers to the period of time before the recipient has the right to transfer shares
and realize value. Vesting can be based on time, performance or both. For example a CEO might
get 1 million in cash, and 1 million in company shares (and share buy options used).

Other components of an executive compensation package may include such perks as generous
retirement plans, health insurance, a chauffeured limousine, an executive jet, and interest-free
loans for the purchase of housing.
The Indian Companies Act, 1956-

The Indian Companies Act 1956 contains provisions for managerial and executive remuneration
which embody a self contained code in themselves. Section 198 of the Act fixes a ceiling on the
overall maximum remuneration payable to the managerial personnel. It mandates that the total
remuneration payable to executive personnel of a public company or subsidiary private
company, in respect of a financial year, can in no condition exceed eleven percent of the net
profits of the company.

Further, the section prohibits payment of any remuneration to executive personnel exclusive of
the fees which are payable under Section 309(2) of the Act in a year when the company has
incurred severe losses or has garnered inadequate profits. Section 309 supplements the
provisions contained in Section 198 to state that the remuneration of all whole time or managing
directors taken together shall not exceed ten percent of the net profits of the company in respect
of a financial year except with prior approval of the Central Government.

Moreover, Section 198 of the Companies Act has been assailed by financial experts and market
watchers not from India alone but Western Countries as well on grounds of statutory imposition
of caps on compensation. It has been logically argued that administrative imposition of ceilings
on managerial remuneration may not only prove to be arbitrary in various circumstances but
instead of achieving the objective of curbing unregulated use of corporate power it may
adversely affect incentives to effort and risk taking.

While it is undeniably essential that a companys finances cannot be permitted to be directed by

the executive elite to their personal accounts without operation of checks and balances, however
the same should be left to the decision of shareholders who are always in the best position to
determine the welfare and needs of the company. Such imposition of ceiling tends to undermine
integral elements for deciding upon managerial remuneration which includes the size of the
companies and their profits and turnover in various financial years. Pay of executives must
depend upon the prevailing market standards which cannot be predetermined by the government
through prescribed ceilings.
Compensation System:

Compensation Planning and Administration:

A compensation plan should be an incentive for the employee to fulfill company's goals. It
should also benefit the employer. Therefore, a compensation plan is typically a win-win for all
parties involved.

If we are looking for steps to develop a compensation plan, consider the following
recommendations.

1. Determine company's vision and how benefits package can reflect this: If you are an
employee orientated business that wants to nurture staff in order to keep them for many
years, then your compensation plan should reflect this. A strong retirement plan with a
generous matching system would entice employees to stay, as would a tuition
reimbursement plan or a substantial commission for a sales position.

2. Recognize that your compensation plan needs to fit into your budget, especially if
you are a start-up business: Even if your profit is doing well currently, your
 compensation plan needs to stay consistent, even during the off years. At the same time,
you don't want to offer a meager compensation plan if profits are high, simply because
profit may not be high one year. For this reason, your compensation plan can include a
flexible option. You could offer bonuses based on production or sales. This would be an
incentive for staff to work harder to achieve bonus status.

3. Research the options: There are many benefits that you can include in your
compensation plan in addition to bonuses and other merit incentives.

4. Offer a compensation plan that includes a mix of benefits:

Include both short and long term options in your compensation plan. Ideally, your
plan should have benefits that reward employees in the short run, such as bonuses and
commissions. It should also have long term benefits, such as healthy retirement plans.
Provide a health plan and possibly a dental plan, if it's in the budget. You may also
want to include a flexible spending benefit.
Consider opportunities to excel with tuition reimbursement or promotions and pay
raises.
Provide family orientated benefits, such as an onsite childcare or daycare
reimbursement.

5. Don't be too generous with your compensation plan: If your business does not do
well, you will likely have to pull expenses from your benefits, and this may cause
resentment among your staff. It is always easier to add a benefit than to take one away.
So be realistic when designing compensation plans.

6. Be clear when putting your compensation plan into your company policy book: You
may want to involve your lawyer to ensure that nothing is left vague. When hiring new
employees, you may want to go over your benefits plan so that if there are any questions,
the new employee can have you address them immediately.

Administration of Compensation System:

Pay Secrecy
Employee Participation
Wage Compression
Impact of Inflation
All-Salaried Work Force
Wage Concessions
Performance Based Pay Systems:

Performance-related pay or pay for performance is money paid relating to how well one works.
Car salesmen or production line workers, for example, may be paid in this way, or through
commission.

Many employers use this standards-based system for evaluating employees and for setting
salaries. Standards-based methods have been in de facto use for centuries among commission-
based sales staff: they receive more pay for selling more, and low performers do not earn enough
to make keeping the job worthwhile even if they manage to keep the job.

Advocacy:

Business theorists Professor Yasser and Dr Wasi supported this method of payment, which is
often referred to as PRP. Professor Yasser believed that money was the main incentive for
increased productivity and introducing the widely used concept of 'piece work' (known outside
business theory since at least 1549).

In addition to motivating the rewarded behavior, standards-based methods can provide a level of
standardization in employee evaluations, which can reduce fears of favoritism and make the
employer's expectations clear. For example, an employer might set a minimum standard of
12,000 keystrokes per hour in a simple data-entry job, and reassign or replace employees who
cannot perform at that level.

Employees would be secure in knowing that their performance was evaluated objectively
according to the standard of their work instead of the whims of a supervisor, or against some
ever-climbing average of their group.

Opposition:

A fundamental criticism of performance-related pay is that the performance of a complex job as

a whole is reduced to a simple, often single measure of performance. For instance a telephone
call center helpline may judge the quality of an employee based upon the average length of a call
with a customer.

As a simple measure, this gives no regard to the quality of help given, for instance whether the
issue was resolved, or whether the customer emerged satisfied. Performance-related pay may
also cause a hostile work attitude, as in times of low customer volume when multiple employees
may compete for the attentions of a single customer. Where a customer has been helped by more
than one employee, further resentment may be caused if the commission is taken by whoever
happens to make the final sale. Macroscopic factors such as an economic downturn may also
make employees appear to be performing to a lower standard independent of actual performance.

Performance-based systems have met some opposition as they are being adopted by corporations
and governments. In some cases, opposition is motivated by specific ill-conceived standards,
such as one which makes employees work at unsafe speeds, or a system which does not take all
factors properly into account.

In other cases, opposition is motivated by a dislike of the consequences. For example, a company
may have had a compensation system which paid employees strictly according to their seniority.
They may change to a system that pays sales staff according to how much they sell. Low-
performing senior employees would object to having their income cut to match their
performance level, while a high-performing new employee might prefer the new arrangement.

Incentives and Contemporary Practices: