This paper examines the key considerations traditionally used to determine CEO compensation, focusing on the five primary reward components common to executive pay packages: salary, annual bonuses, incentive plan payouts, and stock-based grants. It proposes a pay-for-performance evaluation matrix tied to return on investment, shareholder return, and peer benchmarking, and assesses how well such tools transfer across industries. The paper also explores how technology can support or complicate the CEO evaluation process, contrasting digital challenges with traditional performance management hurdles. Finally, it considers whether current compensation factors will remain relevant over the next decade given evolving corporate governance practices and shifting pay structures.
Many reward compensation packages adopted by CEOs in this era contain five primary components: limited stock grants, limited option grants, payouts for incentive plans, annual bonuses, and salary. While the amounts of bonuses, compensation, and perquisites found in not-for-profit sectors may pale in comparison to those in the for-profit world, they generate complex reactions. Their existence can ignite debate, especially in periods of shrinking budgets and increasing costs. However, the ability to hire, retain, and compensate CEOs is essential in all sectors, and is typically achieved through a variety of executive compensation plans. The issues surrounding the design of these systems in both the business and not-for-profit sectors are similar (Bhattacharyya, 2011).
The last two decades have witnessed a dramatic transformation of executive compensation in many organizations. Compensation of top executives has grown considerably faster than that of ordinary workers. As of 2003, the typical large-firm CEO earned approximately 500 times what ordinary employees earned. Consequently, the numbers involved have become quite substantial. Over a span of five years, CEO compensation across each company in the widely used ExecuComp database, aggregated over 1,500 companies, totaled approximately $100 billion (Bebchuk & Fried, 2004). CEOs effectively set their own salaries. As a result, even though CEOs are under a fiduciary responsibility to expand shareholder value, compensation plans for CEOs often fail to provide proper incentives to do so and may even cause shareholder and executive interests to diverge.
Pay-for-performance would be the most useful tool for calculating CEO compensation. In order to establish defensible compensation decisions in the current era of corporate governance and engaged investors, management needs new tools such as pay-for-performance. This approach must be linked to key business metrics, targets, and business strategy. The tool identifies the total cost of a CEO relative to:
(i) Return on invested capital, excluding the cost of capital; (ii) Shareholder return; (iii) a 10-year Treasury benchmark; and (iv) six chosen comparable professional organizations with corresponding compensation adjusted for the level of work complexity or the scope of the CEO's role. Boards need performance metrics and evaluation periods that help them assess the sustainability of the business strategy, whether it will allow the company to create value with the capital provided by investors, and if so, by how much (Chingos, 2002).
In order to make defensible compensation decisions, boards need to look beyond the previous one to two years of operational performance, unless the company is being prepared for sale. Three-to-five-year performance periods should be the minimum benchmark for pay-for-performance planning and evaluation. Executives can leave no better legacy than ensuring the long-term stability and viability of the organizations they lead. To achieve this, directors need new procedures and tools — such as pay-for-performance — to help them precisely determine the performance metrics and accountability standards for CEOs in alignment with the company's strategic plan. For pay-for-performance to become a reality, directors must be fully informed and must test whether the executive pay programs and policies they approve genuinely lead to the creation of real and sustainable value for investors.
There is limited efficiency for performance-based compensation tools across diverse sectors. A tool that works effectively in one setting cannot simply be transplanted and expected to function in another. Therefore, the kind of evaluation tool used in health care is not necessarily applicable to transportation. Each sector has its own unique characteristics. At the same time, there are enough parallels to carry out a meaningful evaluation across some industries. Health care, for example, is not the only sector that involves collaborative production; education shares this characteristic as well. In education, while there is a lead instructor who is "first on deck" — much as a physician is in health care — that instructor's performance is ultimately influenced by other educators and many others engaged in the academic process. Similarly, in health care, CEOs often oversee teams engaged in coordinated care. In such cases, the appropriate unit of accountability may not be the individual executive alone, but perhaps the team as a whole.
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