The role of executives in a corporation

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Introduction

The role of executives in a corporation within a principal - agent framework has become crucial to the success of a corporation. In order to remain competitive in the changing business environment, the top executives of the corporation are well compensated to achieve the company’s objectives. The executive compensation is an important strategy in a corporation in order to provide reward to the executives that has vital role in the future development of the company. However, high compensation to the executives does not imply that the company is profitable, but might be resulted in loss to the company which can be seen in the case of Marriott International where the executives are highly paid but stock price was drop 28 percent during the year of 2007. There are two types of compensation packages which are the fixed pay such as the salary and variable pay which is equity based such as stock option and restricted stock.

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Literature Review

A survey conducted by Devers et.al (2007) has revealed several benefits from the executive compensation. Goal alignment between the executives and the owners is one of the benefits of received from the executive compensation. They argue that the executives would be more focused on maximizing shareholders wealth rather than extracting opportunistic rents when the executives are satisfied with the compensation paid to them. Other than that, they found that when stock-based compensation is received by the executives, voluntary information disclosure to the investors is more likely to occur. Disclosure of this information will reduce information asymmetry as well as enables the management of the company to be more transparent. The disclosure of internal information to the owners of the company will enable the monitoring process to become easier. The disclosure of information also increases the confidence of the investors who are treated unfairly when the management of the company has insider information while they do not.

The compensation policy to the executives can also influence the policies employed by the executives. Devers et.al (2007) demonstrate the effect of equity-based compensation on liquidation policy exercise by the company. When the executives are compensated with equity-based compensation, they will be likely to exercise voluntary liquidation which can protect the interest of shareholders by minimizing the loss suffered by the shareholders. They also argued that the executive compensation has significant impact on the motivation and the performance of the executives. Attractive compensation will motivate the executives to perform well and increase the value of the company. This also enables the organization to recruit the right personnel as well as capable personnel also can be retained. Capable personnel can also influence the development of the company that will generate wealth to the owners of the company.

Effective executive compensation can provide benefits to the organization, to the shareholders and other stakeholders, there are also limitations faced by the organization on the compensation rewarded to the executives. One of the major limitations of executive compensation is misstatement of information of the organization. In Efendi et.al (2007), they argue that the executives are obtaining short term benefits from the misstatement of the accounting report. This contrasts from the goal alignment suggested by Devers et.al (2007). The executives also have the intention to misstate the earning of the company when the cash bonus paid to the executives is directly linked to the company’s earning. This can affect the wealth of the shareholders when such wealth transfers from the shareholders to the executives. However, when the executives are compensated with the salary based compensation, they will less likely to involve themselves in misstating the earnings (Efendi et.al, 2007).

Efendi et.al (2007) also mentioned that when the value of options granted by the executives through option grant increase in value, the conflict of interest that arisen between the executives and the shareholders will be enlarged. This is due to the performance required to validate the increment of stock value is unable to be demonstrated by the executives. Hence, the executives will carry out actions to produce results that reflect the inflated price of the stock. This also supported by the survey of Devers et.al (2007). Executive compensation also has the effect on the tax sheltering that beneficial to the owner of the company as stated in Devers et.al (2007). The executives tend to give up the opportunity to get tax sheltering to prevent the accidental detection of their unethical actions. This action by the executives not only will be costly to the shareholders in term of profitability, it will also accumulate on the unethical activities carried out by the executives.

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Investors, and government agencies as well as other stakeholders are mainly concerned on the disclosure requirement on the executive compensations in order to protect their interest. The disclosure of the executive compensation can be affected by several factors as discussed in Andjelkovic et.al (2002). Andjelkovic et.al (2002) suggested that the importance of information disclosure to the public is not significant as the board of directors has been employed to overlook the management of the company. However, when the director’s welfare is more aligned to the company insiders compared to its shareholders, then the disclosure of executive compensation will become more important. The disclosure of the information on executive compensation scheme is important to prevent the over lenient compensation scheme. The failure of the organization to disclose the information will cause the shareholders to have limited knowledge in the current affair of the company.

Conclusion

In conclusion, the executive compensation scheme in practice currently by most of the companies worldwide is ineffective in terms of the goal alignment between the executives and the owners. Many problems still exist such as the information misstatement by the executives in order to obtain temporary benefits. Such compensation also must exist in order to give motivation to the executives to increase the shareholders’ wealth. However, modification of the scheme is more recommended for goal alignment purpose. One of the developments in the compensation scheme is to swap the stock options that widely practiced to the restricted stock that require certain requirements to be met before the stock is transferred. The recent amendment of the laws and regulations on disclosure requirement by the governance bodies such as corporate governance have intended to overcome the limitation of executive compensation in order to protect the interest of the company’s owners.

Appendix A

References

Andjelkovic, A., Boyle, G., McNoe, W. 2002. Public Disclosure of Executive Compensation: Do shareholders need to know? Pacific-Basin Finance Journal. Vol. 10. Issue 1. January.

Devers, C.E., Cannella, A.A. JR., Reilly, G.P., Yoder, M.E. 2007. Executive Compensation: A Multidisciplinary Review of Recent Developments. Journal of Management. Vol. 33. Issue 6. December.

Efendi, J., Srivastava, A., Swanson, E.P. 2007. Why do corporate managers misstate financial statements? The role of option compensation and other factors. Journal of Financial Economics. Vol. 85. Issue 3. September

Bibliography

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