Executive Compensation: Don't Blame the Pay Problem on the Incentive System

Essay by getbackerUniversity, Bachelor'sB, November 2006

download word file, 2 pages 3.0

The public has been criticizing about the exorbitant amount of money that CEOs are making and questioning the validity of the compensation system; however, it is the external factors that cause this excessive growth in the executive compensation package rather than the stock options compensation schemes. In Lublin and Thurm's article, Behind Soaring Executive Pay, Decades of Failed Restraints, it suggests that it is the critics' efforts to restraint CEOs' pay that cause the executive compensation to skyrocket over the decades. It was the disclosure requirements that make the compensation plans competitive. Instead, the use of stock options as performance measures does align the stakeholders' incentives with CEOs' incentives.

The stock option compensation actually strengthens the link between pay-for-performance for CEOs as "stock option valuations account for 98% of the link between pay and performance for the average chief executive..." (Hall, 2000, 124). Ever since the companies started to use stock options as compensation tool since 1980s, the linkage between pay and performance has increased tenfold because CEOs are treated like owners rather than bureaucrats and they are being paid for the increment of the company's value (Hall, 2000, 124).

Stock price embeds "all value-relevant information" about the company where as accounting system only reflects the economic value added information. (Dutta & Reichelstein, 2005, 1069). Value added information such as company reputation and social capital are less likely to be manipulated in comparison to economic information. With stock option incentive in place, managers will strive for the optimal market and economic result instead of constantly trying to meet the bottom line of meeting revenue growth target. Therefore, stock option incentive reinforces forward-looking mindsets when executives are assessing investment opportunities.

CEOs do try to increase the share price when their compensation is heavily based on equity incentive, because...