Executive Compensation Scheme And Financial Crisis Accounting Essay

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At the heart of the financial crisis that has paralyzed global financial markets is a mystery due to murky world of executive compensation, and efforts to prevent similar catastrophes in the future could depend on unlocking its secrets (C.Keller e.t al, 2008). Executive compensation scheme is a term for all the components that make up remuneration package of chief executive officers and top level managers of Business Corporation. 'As executive compensation has spiraled up in the last couple of decade, many observers believe that top corporate executives are benefiting themselves at the expense of shareholders' (Texas law review). Executives are group of vital importance to the operation of the organization and it's important to attempt to individualize compensation for each of them. Even they are small part of organization but they represent a disproportionately high percentage of total wage costs. It is necessary to develop measures of individual performance that are tied to organizational performance, since it is of utmost importance that managers associate themselves with organizational success. The compensation schemes are prepared to benefit the executive without being perceived under this approach. The executive compensation scheme based upon some objectives such as attract and retain executives responsible for the company's long term success, reward executives for achieving both financial and strategic company goals, align executives and stockholder interests through long- term, equity-based plans and provide a compensation package that recognizes individual contributions as well as overall business results. Executive compensation scheme is designed to provide a mix of fixed compensation tied to the achievement of specific business objectives and corporate financial goals (both short and long term), as well as to the attainment of the executive's individual performance objectives. The dominant components of executive compensation are base salary, annual cash incentives tied to annual corporate and individual performance and long term incentives in the form of restricted stock units, stock option and other stock based awards designed to give the executive a continuing stake in the long term success of the company and to align the executive's interests with those of stockholders. In addition, executive officers receive other benefits that the company believes are reasonable and consistent with its overall compensation scheme. These include supplemental retirement programs, executive life insurance and executive's perquisites. Typically, pay of CEO's and other executives is set to be competitive with other executive salaries in the market thus may be very high in comparison to the pay of employees in their own company. The use of compensation beyond base salary is intended to motivate executives to reach certain organizational performance goals. 'The Mercer study indicates that the CEO's of 100 major American corporations had a median bonus of $1.14 million in 2004, which equaled 141 percent of their annual salaries' (Marcia. J.S, 2004). Thus, this sample concludes that bonuses accounted for more money that the CEO's annual salary.


Executive Compensation Scheme (ECS) plans have been designed to attract, retain and motivate key management. In today's environment executive compensation has become identical with corporate surplus and managerial irresponsibility. (Oehmann. H, 2010). The long-held view is that compensation contracts observed in the market place have been designed to give strong incentives for the CEO to exert effort for the interests of the shareholders. The assumption of variable compensation as an incentive for hard work has been compromised in thought of the fact that significant systematic risk underlies observed contracts. 'A well designed ECS can mitigate, but not avoid all types of agency conflict related problems by tying the fate of managers to parents felt they could buy themselves out'(Bahar.R e.t.al, 2005).ECS arrangements often fail to provide executives with proper incentives so to do and may even cause executive and shareholder interests to diverge. It's clear that a company might face a lot of problem due to poorly designed ECS.

Company directors and executives are self-interested actors who using their position in the company to pursue their own ends rather than being focused on pursuing what are best for the company and its stakeholders. The news of the record 25 years jail punishment handed down to former World.Com boss Bernard Ebbers for his part in the fraud that caused the $ 11 billion collapse of that company. In similar, reports of overly exuberant ECS arrangements at US insurance company Farnie Mae, in which large rewards were provided to company executives even if the company failed or their own performance was not up to standard. Indeed, according to Robert.C.Clack a professor of Harvard explained that the collapse of Enron and a host of other corporate scandals, resulted in a 'social facilitation' (a term derived from social psychology) was due to bad corporate behavior rather than normal economic forces. The performance effort connection questions whether it is the executive or other environmental factors that lead to the organizational results for which the executive is rewarded. At times it may be true that the executive gains from improvement in the general economy rather than from their own efforts. Of course, the reverse is also true, the executives gets blamed for poor performance that may not be their fault. Unfortunately, executives often receive large walking bonuses even when their companies falter. While Kmart lay off 22,000 workers without severance pay, Conaway one of the company's executive walked away with $ 9 million. The other evidence is Webvan an online grocery company's executive George Shaheen left the company few months before it closed its doors, taking a severance package of $ 375,000 per year for life. There are some other companies which collapsed due to overpaid executives without performance such as AIG and Merrlyl Lynch.

'Compensation arrangements have often deviated from arm's-length contracting because directors have been influenced by management, sympathetic to executives, insufficiently motivated to bargain over compensation, or simply ineffectual in overseeing compensation'(Stark. M, 2004). Compensation schemes are claimed to be 'the product of arm's-length bargaining' for managers to get the best possible deal for their benefits without worrying about company's performance in the future. Financial economists reliable to the arms- length bargaining model assume that compensation schemes are generally efficient, while courts generally defer to decisions by the board of directors. Bebchuk and Fried started at the same point as the arms -length bargaining model which they set up as their principal foil-namely, with the principal- agent problem. Their managerial power model assumes that the problem agency costs' arising out of the separation of ownership and control is the central concern of corporate governance. Most shareholders and economic criticisms of CEO pay at the time focused on the lack of meaningful rewards for superior performance and meaningful penalties for failure. Similarly, although the populist attack was totally focused on reducing pay levels, it was implied in terms of increasing the relation between pay and performance. Both of these forces combined to facilitate more pay for performance, predominately in the form of stock options. Stock options seem a natural way to tie executive pay to company stock- price performance. The most pronounced trend in executive compensation in the 1980s and 1990s has been the explosion in stock option grants which is single largest component of CEO. In particular, level of pay and pay performance sensitivities in the world have increased substantially over the past decade which driven primarily by an explosion in stock option compensation.(art 5) One widespread and persistent feature of stock option plans is that fails to filter out stock price rise due to industry and general market trends. Thus it's completely unrelated to manager's own performance but then still they get blamed. Windfall is the different ways of designing stock option plans. There is some possibility to avoid managers from receiving no pay off from the option plan when the implement price of an indexed option is linked to market. For example, the implemented price could be indexed not to changes in the market but rather to changes in a lower bench-mark. Such plans would have high probability of out performing the bench mark and receiving a payout. There is wide variety of reducing wind-fall options available which would probably be optimal in many firms to filter out at least some of the increase in the stock price that has nothing to do with manager's performance.

Optimal contracting arrangements might call for very large amounts of compensation for executives, if such compensation is needed to provide mangers with powerful incentives to enhance shareholder value.(art 2) The significant part of compensation that is not equity based has long been criticized as weakly linked to managerial performance. The weak link between manager's performance and their non- equity compensation have ever more looked to equity based compensation to provide the preferred link between pay and performance. Tournament theory views the promotion ladder in the organization as a series of tournaments and thus managerial power is an aspect in the theory. Managerial power model, there is much competing evidence suggesting that executive compensation packages are designed to align shareholder interests. The principal constraint on managerial power in Bebchuk and Fried's account is the risk of incurring "outrage".(art1)

In similar, they also many authors explained that one important block of the managerial power approach is "outrage" costs and constraint. Outrage might cause embarrassment or reputation harm to directors and managers, and it might reduce shareholders' willingness to support incumbents in alternative contests or takeover bids. The more outrage a compensation arrangement is expected to generate, the more reluctant directors will be to approve the arrangements and the more hesitant managers will be to propose it in the first instance. The net effect of managerial power is that CEO pay packages are higher than would obtain under arm's-length bargaining and less sensitive to performance. Although equity-based compensation has recently dawn the most attention, much executives pay comes in forms other than equity, such a salary and bonus. Cash compensation including bonuses has been at best weakly linked with firms' adjusted performance.