By Ben McClure Updated Aug 2, It's hard to read the business news without coming across reports about the salaries, bonuses, and stock option packages awarded to chief executives of publicly traded companies.
Making sense of the numbers to assess how companies are paying their top brass is not easy. Investors must ensure that executive compensation is working in their favor.
Looking at Management Stock Options
Here are a few guidelines when analyzing a company's compensation program. Risk and Reward Company boards, at least in principle, try to use compensation contracts to align executives' actions with company success.
A pay-for-performance policy is based on the concept that a CEO's compensation reflects the performance of the company. While most can support the idea of paying for performance, the concept implies that CEOs take on risk.
Re-examining Stock Options as a Way to Compensate Executives
A CEO's fortunes should rise and fall with the company's fortunes. When examining a company's compensation program, check to see how much stake executives have in delivering profits for investors. The following are different forms of compensation and a description of how they can put a CEO's reward at risk if performance is poor.
In other words, the CEO is rewarded substantially when the company does well. However, the CEO is also rewarded when the company performs poorly. On their own, large base salaries offer little incentive for executives to work harder and make smart decisions. Key Takeaways Pay for performance is a compensation strategy to align executive compensation with the company's success.
Base salaries for CEOs are often high but offer little incentive for hard work or options from top managers management. Bonuses that are linked to company performance will encourage CEOs to work harder and make better decisions for stockholders.
Stock options can cause CEOs to focus on short-term performance or to manipulate numbers to meet targets.
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Executives act more like owners when they have a stake in the business in the form of stock ownership. Bonuses Beware of bonuses.
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Bonuses that vary with performance are another matter. CEOs who know they'll be rewarded for performance do tend to perform at a higher level because they have an incentive to work hard.
What You Need to Know About Stock Options
But using simple measures to determine appropriate pay for performance can be tricky. Executives can be unfairly penalized for one-time events and tough choices that might hurt performance in the short term or cause negative reactions from the market.
However, options are also have flawed as a form of compensation. In fact, with options, risk can be badly skewed. When shares go up in value, executives can make a fortune from options. But when share prices fall, investors lose out while executives are no worse off.
Options can even prompt top managers to manipulate the numbers to make sure the short-term targets are met. That hardly reinforces the link between CEOs and shareholders. CEOs can truly have their interests tied with shareholders when they own shares, not options. Ideally, that involves giving executives bonuses on the condition they use the money to buy shares. Let's face it, top executives act more like owners options from top managers they have a stake in the business.
The form discloses the frequency of stock option grants and the how to make big money on the internet of awards received by executives in the year.
It also discloses re-pricing of stock options.
What You Need to Know About Stock Options
However, note the table's accompanying footnotes. The footnotes show how many of those shares the executive actually owns and how many are unexercised options. Again, be reassured when you find that executives have plenty of stock ownership. Annual bonuses that do not vary with the company's performance are merely additional base salary for CEOs.
- Metrics details Abstract This research examines the effect of the characteristics of top managers on the strategic options of firms in different industries.
- Stock options were just a footnote.
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- The short answer: It depends on the philosophy and goals of the company.
Conclusion Assessing CEO compensation is an art. Interpreting the numbers is not straightforward. However, options from top managers should get a sense of how compensation programs can create incentives— or disincentives—for top managers to work in the interests of shareholders.
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A Guide to CEO Compensation
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