Bright And Dark Side Of Executive Equity Compensation Accounting Essay

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In the organizational hierarchy, top most executives are 1-5% of the total workforce. They are in-charge of growth and prosperity of the firm. Thus compensation paid to this category is closely associated with the success of firm as a whole. Hartzell and Starks (2003) concluded that institutional monitors provide much greater incentives to executives so that they can perform well and earn more incentives while at the same time reducing their salary (fixed-pay) by a great deal more. According to agency theory top managers of the firm are the agents of the stock holders and it is assumed that interest of both of them are the same which in real term are not. So shareholders can attempt to arrange in a line the interests of top management with their own by providing them with attractive compensation packages.

Compensation is measured and broadly distinguished between two categories:

A. Direct compensation

1. Salary

2. Bonus

3. Other cash compensation

4. Option grants

5. Restricted stock grants

B. Firm-related wealth change

1. Stock options

2. Incentives stock options

3. Non-qualified stock options

4. Value change of option holdings

5. Value change of restricted stocks

6. Profits from exercising options

7. Value change of direct equity holdings

Basic salary

Basic salary is the standard salary of the executive which also administer pension entitlements and life insurances. Salaries paid to executives are often influenced by the board of directors which often depend on information from salary surveys of similar companies. Pay of top executive and other executives are set to be competitive with other executive salaries in the market and thus may be very high in comparison to the pay of employees in their own company.


Bonuses are considered to be compensation associated with the performance of the executives and/or employees. They are paid in addition to salary or wages. Although profits may be one of the most popular organizational measures which can be measured in terms by organisations earnings per share, return on equity, return on capital and return on assets.

Equity compensation

Executive compensation consists of basic salary, bonuses, long-term incentives, benefits, and perquisites. Generally people look at high salary of executives as the problem of equity, whether rewards are higher than the contribution towards the organisation.


Pension in general depends on the basic salary of any executive. It shows that the company is concerned about the long term interests of its employees and is a good employer which helps company to retain high-quality people.


Benefits for executive-level employees are likely to be different than those offered to lower-level employees. Executives will often receive high levels of distinctive company fringe benefits, like health insurance, life insurance, and pension plans. Additionally, some executives may also have a contract for large severance packages, paying cash and stock options to a CEO fired from a company. Many executives negotiate generous severance packages at the time of hire, so that even if they are unable to deliver upon promises to the company, they can collect compensation upon exit.

Long Term Incentives

Incentives are rewards that are linked to specific long-term goals of the organization. The most common long-term incentive is the stock option, which either gives the executive free company stock, or allows him or her to purchase company stock at a reduced price for a period of time. These stocks become more valuable as the company improves financially, and therefore, ownership of stock is intended to encourage the executive to make the organization more profitable.

Generally people get influence by high salary of executives as the problem of equity, whether rewards are higher than the contribution towards the organisation. There pay is hence only the line of implications of their actions (Shaq vs. George Miken). As they play an important role during the span of their term so they will be awarded with high pay (includes bonuses and other incentives). In 1974 the Yankees signed Catfish hunter for $3.75 million a five year contract and everyone was convinced it was the end of the sport and 30 years later players are making well over $10 million contract with some much higher. Alex Rodriguez signed a 10 year 275 million contract, yet baseball endures to pay the big bucks. And the same things are happening in the sports and other business world. Most of the research on executive compensation is after 1992 because of Compustat executive compensation database (ExecuComp) where it provides summary compensation data, as well as full details on executive stock and option awards as well as pension plans allowing you to see the complete picture of how executives are compensated.

Bright side:

Performance based incentives brings out more of growth opportunities within the company, it also involves more of risk taking and promotes long term orientation. A candidate might be more likely to come to work for the company if certain promises are locked in by a contract, such as base salary, bonus, benefits and causes for termination. It’s an advantage for the company as it involves minimal administrative costs and record keeping. Special allowance such as overtime, mobile allowances, meals, commissions, travel expenses, reduced interest loans; insurance, club memberships, etc. can be granted to employees to provide them social security and motivate them which improve the organizational productivity. Bonus are not just rewards for an employee's past performance but it also holds an impression of company's performance in the market.

Dark side:

The basic salary, bonus, incentives, and benefits for executives have raised serious questions about the repercussion of such pay. One concern about the high pay level for executives is that they may encourage executives to make business decisions that benefit themselves rather than the organization in order to meet performance goals necessary to receive incentive pay. For example, an executive may drive up short-term profits that cannot be sustained, only to collect a large bonus and leave the company before long-term financial problems are revealed. A second concern of high executive pay is the use of stock options as an incentive. Recent evidence of illegal practices in some high-profile American companies has prompted the enactment of the Sarbanes-Oxley Act of 2002. This act prevents executives of companies from keeping profits or bonuses acquired from selling company stock if they have misled the public about the financial health of the company to increase stock price.


Finally, some question the ethics of the high level of executive pay when lower-level employee pay has not risen at the same rate. There is a continually widening gap in compensation in different levels of organizations; for instance, the Mercer study described previously determined that CEOs enjoyed bonuses of 141 percent of salary in 2004, while other studies indicate that typical clerical and technical staff earns approximately 5 percent of salary as an annual bonus. Although some argue that executive level positions deserve high rates of pay due to the nature of the job and the high level of responsibility involved, others argue that the gap in executive versus typically employee pay has widened so dramatically that employees are under-compensated and may even be tempted to engage in unethical behavior, such as stealing from the company.

More recently, Moeller, Schlingemann and Stulz (2003), document significant negative announcement returns and substantial losses to large acquiring firms, especially for acquisitions occurring after 1997. Although many researches have been conducted regarding executive compensation but still there are unclear query of high performance relates to high performance by the managements.


In this paper we established a benchmark approach role of top management incentives and firm performance in influencing financial misrepresentations. Compensation made to employees established to have prominent effects on both company's investment manners and subsequent company's performance in the market. All types of options, including car allowances, life insurance, relocation payments, flexible start dates, signing bonuses, use of company-owned vacation property, health-club membership, tuition reimbursements, and other compensation should be considered to make the package competitive and attractive. Many researchers have highlighted the importance of incentive compensation in their works; it brings an outstanding impact not only for the growth of employees but also acts as a boosting factor for company's performance in competitive scenario.

Company's investment and performance are both responsible and effective for bonus payments. Bonuses are not just rewards for an employee's past performance but it also holds an impression of company's performance in the market.