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Evaluation of CEO Pay and Performance Structures

2141 words (9 pages) Essay in Finance

08/02/20 Finance Reference this

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Chief Executive Officer’s reward is not a simple area of focus altogether. Their latest increase in payment has of late attracted lots of attention and has, therefore, spurred a lot of debate across the globe about the nature of their compensation, and the setting at large. However, many argue that the pay-setting of CEOs is as a result of their great managerial settings, the responsibilities accompanied by settling of the firm are rent together. Others say that their high compensation is due to the managers setting their pay. This essay surveys the recent work on the payment of CEOs. There are various studies about what determines the compensation of CEOs however many views the CEO compensation as more of the managers getting their shares while others consider it a way of managerial power theory. In this paper, I will describe the optimal evidence of what determines CEO pays and talk on factors such as administrative power and the competitive market forces playing critical roles in the high pay of the CEOs. This work, therefore, summarizes the market research on chief executive officers and finds the possible evidence on the claims as mentioned above on CEO high compensation. It talks about the two factors, managerial capabilities and highly competitive market factors as the primary influencers of the CEO pay. The evolution of the position of CEOs can be traced to the years the 1970s, and it is divided into various distinct sectors. This division is propelled by sensitivities of low-level pay, top manager’s dispersion and pay performance.

The literature on CEO compensation is, therefore, a broad discussion, from rent extraction to optimal contracting. This review is consequently very comprehensive, and only talks about the various contributions the high pay of the CEO is aptly focusing the objective empirical work rather than theories with the help of Murphy review of 1999. The paper is arranged in a way that has sections. Section 1 primarily deals with the description of the compensation of CEOs. Sections 2 mainly talks about the link between the nature of performance by CEOs and their roles in firms to ensure success. Section 3 s all about the critiques that high CEO compensation receives on a daily basis while section 4 discusses the significant effects the top CEO compensation has on firm then the last section concludes the whole research.

Section1: Structure of CEO pay

a).   Level of CEO pay

The high rapid in an increase of CEO compensation has been profoundly witnessed over the last thirty years. Its rapid increased can be seen way back in the 1990s. The documentation of the rapid increase has, therefore, attracted various analysis ever since. Frydman and Saks (2010) analyzed the 50 largest firms in the years 1940’ 1960; 1980 and 1990 and collected information on CEO compensation of all those firms. He, therefore, concluded that the total compensation of the CEOs consists of their intended executive salary, bonuses, allowances and payouts for incentives; all these are also payable in stocks. It is, however, documented that the executive compensation experienced a significant fall during World War II, and another decline was seen in the year of 1940s till late of 1940s till late 1950s. The value then steadily rose in the years of 1960s. This rise saw a growth of about 0.8-1.0%. The high increase in their pay, however, was considerably seen in 2005 where the growth grew massively with a yearly growth rate of more than 10%.

b).    Components of CEO Compensation

Many sources have recorded an increased pay all over, but the growth has been seen to be steeper across the large firms resulting in high compensation premium for those who are managing g larger firms. Most CEO payment package has distinct components; the components are bonuses which are annual, interest payouts from incentives, grants, stocks, and salary. Moreover, CEO receive other benefits such pension plans and severance payments in case of misfortunes (Malmendier and Tate, 2015). In the 1950s, CEO payments were primarily based on salaries and maybe the bonuses they received annually. But in the business world of today, the rewards are not discretionary; they are often tied to the factors that shape accounting and are paid in stocks or even cash. In 1960, payments from long-term incentive plans took effect. They include bonus plans according to the production of firms yearly. These rewards are therefore also paid to the CEOs by cash. There is also the stock option compensation; the stock option compensation gives the CEOs liberty to offset remuneration directly to prices of the firm shares, giving the CEOs incentive ability to increase the values of the shareholders. The option was initiated when there was a tax reform in the 1950s; the change taxed at lower capital gains at the expense of labor income (Shue and Townsend, 2017). The stock option, however, has been the essential components of the CEOs pay. In 1992, the stock option compensation paid recorded a 20% pay of the CEOs but magically rose to 50% in the year 2000. Thus, a substantial and significant rise in the high pay of the CEOs was realized. As I try to explain the various stark changes in the component and structure of the CEO pay steadily through the years, I am still open to challenge.

c.)    Forms and payment mode

There are three kinds of CEO pay that are not so much known. These forms are pensions, perquisites and severance pay. Severance pay is administered in case of loss or death. The three modes of payment, however, has been so much in the dark since they are mostly referred to as “stealth” compensation. A prerequisite involves a variety of benefits given to the CEOs. These benefits include maximizing the use of the company’s loans which are below market rates, membership cards, company’s aircraft, apartments, and cars. In December 2006, perquisites benefits recorded an increase of 190% as the SEC disclosure rule was disclosed (Gabaix, and Landier, 2008). The pension is also another way of compensation; however, it is one of the payment modes that the value is yet to be disclosed. According to SEC disclosure rules, pension rates are not to be disclosed whatsoever. However, various finance personnel’s have been able to calculate the values to be 10%.

Section 2: CEO Performance.

a). The level of CEO performance in a firm

Executive pay should be majorly based on their achievements and the actions they take to maximize the shareholders’ value. Besides, there has been a major cause of concern between the shareholders and CEOs. Since corporate ownership was separated from corporate control, there have been questions of executives’ self-interest. It is, therefore, the roles of the shareholders and the managers to monitor executives to put the growth of the firm first and not their well-being.

b).   Optimal incentives

The quantity of optimal incentives has been a question of interest in the high compensation of the CEOs. Sales, profits and market capital are major measures of identifying the performance of a firm. It is through the profit that the pay across the firm solely relies on; the managerial incentive can be quantified by changes in the CEOs pay against the stock performance. About executive payment and shareholders return them the level of incentives can be predicted. The measure of the incentives thus links to the firm’s performance and the wealth of the executives

c).    Measures of wealth performance

The measure of CEOs wealth performance solely relies on the behavior of the executive that can affect the value of the firm. The Murphy statistic is a resourceful measure for activities that can have an adverse effect of the income regardless of how big or small the firm is. Executive’s involvements in various activities, measures of performance and wealth should be keenly taken into consideration (Jensen and Murphy, 2010). The recent findings, however, state that most of the CEOs are highly motivated to perform well but still spend on unnecessary things such as jets.

d).   The setting of incentives optimally

The optimal incentives are governed by various parameters that include, the marginal effort of the CEO, executive’s risk aversion, the executive wealthy and cost of efforts. This can be seen in Murphy’s description of low fractional ownership stakes which are consistent with optimal contracts in case the executive’s averse risks efficiently. The optimal level of incentive can record a decline with managerial effort. The motivations can, therefore, be explained with how the stock returns vary.


Section 3:  CEO Compensation

a).    CEO compensation

            The high pay of the executives that have been consistently under the question about the determinants of compensation. The level of compensation is seen in the ability of the executives to offset their pay and the rent extraction from their firms. Averagely the settlement is viewed as the results of the competitive labor markets that the firms thrive in.

b). Empirical evidence

There are various theories that describe and explain the developed high rise of CEO compensation as well the adopted equity-linked pay as from 1970. It is not a shocking fact that quite some CEOs conduct a better job fitting of the renown stylized facts and cross-sectional models.

c). Hypothesis.

Managerial power lays its support from a wide variety of facts. First, the unlimited use of stealth compensation is considered problematic to explain in case of compensation solely relied on the products of optimal contracts, also, keeping the compensation components away from shareholders is considered rent extraction (Bebchuk and Fried 2004). An increase in CEO compensation is realized whenever there is an exogenous extraction in takeover threats and ultimately declines after regular changes to make the board stronger.

d). Factors that explain competitive CEO pay.

Market and optimal factors have played a key role in explaining the competitive CEO pay. A slight change in the market does appreciate the demand for managerial expertise thus an increase in their wage.  When this occurs, the CEOs with extensive experiences are paid much high than the junior ones. Hermalin in 2005, argued that the dynamic CEO salary is a product of the much strict monitoring of the CEOs by the boards.

e). The value of CEO to firms.

 A CEO in a firm is the second in the chain of command after the board of directors. They are in charge of making decisions concerning the strategy and other policies.  A CEO also assumes the communicator function; these are engaging the press and fellow workers. They also preside over the daily running of the firm.


From this say, it is evident that the payment levels of CEOs have adversely increased over the years. In the 1970s, there was a steady low-level pay of the executives and very few dispersions at managerial level. But from the 1980s onwards, the compensation level grew massively thus widening the differences in payments. The most significant component of pay comes from stock option payment. The arguments in this work also, proves that compensations are factored by wealth to the performance of the firm thus aligning managers and shareholders to the executive performance. The performance of the executives, however, is seen through the evaluation of stocks


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