However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value-based method of accounting prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees. The fair value-based method is preferable to the Opinion 25 method for purposes of justifying a change in accounting principle under APB Opinion No. 20, Accounting Changes. Entities electing to remain with the accounting in Opinion 25 must make pro forma disclosures of net income and, if presented, earnings per share, as if the fair value-based method of accounting defined in this statement had been applied.
Stock options are the most frequently used method in executive long-term incentive grants among top 250 companies. However, other methods are popular as well for executive compensation (see fig. 1 & 2).
FIG. 1 - EXECUTIVE LONG-TERM INCENTIVE GRANT - TYPE USAGE % of TOP 250 COMPANIES
FIG. 2 - EXECUTIVE STOCK OPTION VARIATIONS % of TOP 250 COMPANIES
What are the implications for Managers?
The global discussion around executive compensation had a major impact on the way this is done nowadays compared to threee decades ago. Major changes have been adopted by major corporations which focused on increased corporate responsibility, encapsulating here the responsibility to immediate stakeholders, but also towards the society. Executives and the board of directors were exposed to increased transparency and held accountable easier now than in the past. The current trend aims to reduce the compensation gaps between executive compensation and that of the shareholders, to increase shareholder value and increase corporate performance compared to industry peers. More specifically, the executive compensation packages are a mix of long-term incentives (LTI), which tends to include more and more performance-based packages.
Firstly, executive compensation needs to be incentive enough to attract the right person to lead the company and since the average compensation is high, corporations can't afford to lower it significatly for the simple fact that they would lose valuable leaders to the competition. Secondly, poor performance can't justify a high executive compensation no matter what the perception on the leader's abilities is. Finally, a pure performance-based compensation package can be discouraging for any executives especially in economic recession circumstances. Thus, corporations, executives included need to design a mix of executive compensations that is aligned with everyone's objectives: the shareholders', the executives', the corporation itself and why not the public.
Table 1 displays the pros and cons of three long-term incentive plans including: stock options, restricted stock and performance awards.
TABLE 1 - LONG-TERM INCENTIVES
Stock Options
Restricted Stock
Performance Awards
PROs
Pay-for-performance
Align with shareholders
PROs attraction and retention
Efficient
PROs
Combines pay-for-performance with attraction and retention
Linked to corporate goals
CONs of shares outstanding
Perceived value and the cost attached to it
CONs
No link to pay-for-performance
CONs
Pressure on corporate goals
Too streched goals may reduce attraction and retention
How can this be resolved?
Linking CEO remuneration to company performance is quite a controversial topic and has been building up in the last 30 years. A study made by the Corporate Library (2007) highlights twelve of the largest corporations in U.S., which are characterized by high executive compensation and poor performance over a five-years period. During this whole period, the corporations paid out $865 million to their CEOs who in turn lost about $640 billion in shareholder value. The corporations mentioned in this study include: AT&T, BellSouth, Hewlett-Packard, Home Depot, Lucent Technologies, Merck, Pfizer, Safeway, Time Warner, Verizon Communications and Wal-Mart Stores.
Each of these companies paid its CEO at least $15 million in the two fiscal years available, had a poor performance compared to their competition and had a negative return on stockholders over the studied period.
There has been more concern over the past few years about the link between pay and performance," claims Paul Hodgson, senior research associate at the Corporate Library.
In the past few years, Hodgson says, companies replaced more and more often-controversial stock option programs with restricted stock within their compensation plans. "The problem is that many of the restricted share schemes being used are not designed well. There are too many companies out there that are adopting off-the-shelf versions of the plans without considering what they might do to adapt to their own company's circumstances."
Hodgson also adds that the most common metric based on which compensation packages should be designed is total stockholder return. Even though that does not take...
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