Executive Compensation Essay

7443 Words Jan 11th, 2010 30 Pages
Accounting Theory Assignment

Executive Compensation



Executive compensation together with corporate governance systems has received an increasing amount of attention- from the press, corporations, financial academics and also the government. An executive compensation plan is a major application of the agency theory study and, thus, an agency contract between the shareholders and CEO’s of the business, which attempt to align the interests of the owners and the managers by basing the CEO’s or executive’s compensation on some performance measure of the managers expended effort in operating the organization. Over the last decade scandals such as the Enron and WorldCom have raised many issues and discussion as
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If the committee wanted to base compensation on short-run manager effort, then it would move the compensation to be based more on net income. Conversely if it wanted to base compensation on long-run manager effort, then it would move the compensation to be based more on share price.

Basing the compensation plan more on share price tends to align the interests of the manager more with those of the shareholders. It is still not a foolproof solution though. As we have seen in cases such as Enron, share price does not always reflect the true value of the business. I believe this is why a good compensation plan should be based on information from both net income and share price.

Another important factor for the compensation committee would be to review on a regular basis the compensation plan to ensure that it is still meeting all of the goals and targets that it was designed to. It should also be reviewed with the compensation that was awarded to ensure that the amounts paid are in line with the intended compensation package. See below for an excerpt from the Bank of Montreal Report on Executive Compensation regarding their Annual Compensation Review Process.

Incentive contracts

To begin the discussion about incentives the first question that would occur in most of your minds is, are they necessary? Naturally, “human beings need incentives to encourage them to seek and attain goals”. (Dr. A.L.

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