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A REPORT ON BEST EXECUTIVE COMPENSATION & BENEFITS PRACTICES
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A REPORT ON BEST EXECUTIVE COMPENSATION & BENEFITS PRACTICES

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Executive compensation has always been controversial subject and in the wake of 2008 financial crises it has received much unwarranted attention. This paper is a research on best executive …

Executive compensation has always been controversial subject and in the wake of 2008 financial crises it has received much unwarranted attention. This paper is a research on best executive compensation and benefits practices. We attempt to understand the dynamics behind executive compensation in theory and in practice, by first understanding the importance of compensation and benefits and then by looking at compensation philosophies and types of compensations. Further the report gets into best practices identified by Frederick Crook and Edward Graskamp, and gives examples of companies engaged in best practices

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  • 1. Table of Contents Sr.No 1 2 3 Topic Page No 2 Executive Summary 2 Introduction 4 Importance of Compensation & Benefits 4 4 5 Compensation Philosophies & Types of Compensation and Benefits 5 Executive Compensation & Benefits: A Controversy 6 6 Executive Compensation & Benefits : Best Practices 7 Executive Compensation & Benefits : In Practice 8 Summary & Conclusion 6 7
  • 2. ‘If you pick the right people and give them the opportunity to spread their wings and put compensation as a carrier behind it you almost don't have to manage them’. – Jack Welch 1. Executive Summary: Executive compensation has always been controversial subject and in the wake of 2008 financial crises it has received much unwarranted attention. This paper is a research on best executive compensation and benefits practices. We attempt to understand the dynamics behind executive compensation in theory and in practice, by first understanding the importance of compensation and benefits and then by looking at compensation philosophies and types of compensations. Further the report gets into best practices identified by Frederick Crook and Edward Graskamp, and gives examples of companies engaged in best practices. 2. Introduction Globalization is rampant and the meaning of physical borders is becoming less and less important day by day. We live in a multicultural and multifaceted world which is dominated by multinational corporations, cross border transactions and globalized workforce. As we assimilate into this global era it is imperative for us to understand the importance of human capital, and particularly the importance of ‘executives’. Executives in a corporation are the leaders and the drivers of the organization. Apparently with „great power come great responsibility‟ (Voltaire) and the persisting fundamental debate on executive compensation have become ever more contentious. The global financial crises have completely altered the dynamics as companies are torn between competing demands of shareholders of lower compensation versus motivating and retaining executives with higher compensation. Essentially today‟s leaders should not only be able to manage human resource but also be able to align it with strategy. Executives have started this implementation which has given the concept of „SHRM‟. ‘Strategic Human resource management (SHRM) is the process of linking the human resource function with the strategic objectives of the organization in order to improve performance’ (John Bratton). A multinational corporation without understanding and mastering the management of human capital can neither exploit economies of global scale and scope nor maximize the transfer of knowledge or cultivate global mindset (Govindrajan & Gupta, 2002). A firm‟s executive compensation policies can be powerful enough to even make or break the organization. Executive compensation can be a double edged sword, on one hand it can act as a tremendous motivator and on the other hand a it can lead to disheartened and discouraged employees. Every corporation whether private or public is headed by executives, and understanding executive compensation and benefits becomes an integral part of human resource practices. This research paper is a report on the best practices in executive compensation and benefits. It is imperative to note that though being in the same industry firms differs in their executive compensation and benefits as they vary in their size, culture and history. Creating a common industry wide executive compensation and benefits practices for corporations will not only be unreliable but also be irrelevant. 1|Page
  • 3. 2. Importance of Compensation & Benefits John Maynard Keynes remarked that, “The importance of money flows from it being a link between the present and the future” (Keynes). Keynes is certainly right. As we become more and more globalized and integrate into an open capitalist society an efficient reward system is required whether it be for the lower level employees or be for the executives. A well designed policy can help to acquire, motivate and retain talent in an organization. A motivated employee tends to become more productive, hence more profits for the company. It also leads to job satisfaction, and higher the job satisfaction more are the chances for a low employee turnover. No matter on what hierarchical level an employee is, compensation and benefits policy is of vital importance. Since significant organizational funds are spent on employees, it is critical to match compensation and benefits with goals of the organization (Benefits & Compensation study). Decisions such as legal compliance, cost effectiveness, equity, performance enhancement, and performance recognition and talent management for employees are needed to be made to align with corporate strategy (Human Resource Management, 2011). Ultimately, having an effective executive compensation program in place can create a stronger link between an individual and business goal. 3. Compensation Philosophies & Types of Compensation and Benefits Two compensation theories, entitlement philosophy and performance philosophy lie on opposite ends of the spectrum. Entitlement philosophy assumes that individuals who have worked for a fixed period with little regard for performance differences. Performance philosophy requires that compensation changes reflect compensation changes reflect performance differences. A survey of Fortune one thousand firms found that over eighty percent of the firms use pay for performance systems (Human Resource Management). Rewards can both be intrinsic and extrinsic. Intrinsic reward can be as simple as praise, however extrinsic rewards are tangible and include monetary as well as non-monetary affairs ( (What motivates your employees). Direct compensation, which includes both base pay and variable pay, is a form of tangible compensation). Base pay can be defined as, “The basic compensation that an employee receives usually as a wage or salary is called base pay”. Employee benefits and incentives are normally included in indirect compensation and take many forms. Incentives can be merchandise, spot bonuses, ESOPs, commissions, praise, gain sharing, stock options, improshare plan, scanlon plan etc. Executive compensation plans take their own shape. They also range from salaries, benefits to executive perquisites; however they are altogether on a completely different spectrum. Performance philosophy tends to tether long term goals of a company to the growth and success of the organization. As a matter of fact, long term stock options is one of the most widely used incentive. 4. Executive Compensation & Benefits: A Controversy Executive compensation and benefits has been an extremely controversial subject, and is much highlighted in media and journalism from time to time. A popular view is that excessive 2|Page
  • 4. compensation is pervasive and executives do not necessarily deserve the pay they receive. Further substantiated view tends to explain that all related parties set up the executive prices as well. To illustrate, in spite of the deepening of global financial crises in 2009 financial firms, which needed massive government bailouts, on Wall Street continued to pay massive bonuses. Merrill Lynch and American International Group (AIG), both recipients of the bailout funds were deemed extremely greedy. In 2009 Merrill Lynch allocated three and half billion in bonuses to its employees while AIG paid two hundred eighteen million in bonuses. This even shocked President Barack Obama, who ended by describing the Wall Street bonuses as shameful. (Conyon Martin, 2011). Financial firms are people drive firms, and Wall Street always tries to justify its bonuses. So who is right? This leads us to a very important fundamental question, what are the best practices for executive compensation and benefits? 5. Best Practices in Compensations and Benefits: Theory The usage best principles versus legislative reform as tools for achieving compliance with good practice is an ongoing debate running between the broader corporate governance movements (Deloitte). In the wake of Enron Scandal, Frederick W Crook & Co. devised some best practice which companies can follow in regards to company performance and stock incentives. Companies can use the below stated guidelines to boost company performance without losing focus of long term objectives:          3|Page Use of accounting measures such as earnings per share, return on investment or cash flow in annual and long term performance plans to make sure executives stay committed to operational excellence rather than to short-term stock price growth. Have the external auditors confirm calculations to the compensation committees. Encourage accurate financial reporting Evaluate overall corporate results and executives contribution towards achieving them; include strategic and qualitative performance measures, such as market share and customer satisfaction in addition to financial measures. Raise standards of executive conduct beyond those required by law by using (or issuing) written policies on stock transactions including blackout periods and advance notification for sale. Incorporate retention ratios for stocks earned through incentive or equity plans. Prohibit executives from switching assets from company stock to other investment accounts under non-qualified deferred compensation plans based on inside information or during blackout periods. Prohibit executives from obtaining company loans for the purpose of exercising options or purchasing company stock, and block them from buying company stock on margin or using it as collateral to diversify investment risk. Establish a policy that forbids corporate level-executive and their families from participating in joint ventures or partnerships that have business dealings with the company or in compensation plans based on performance of pieces of the company rather than the whole.
  • 5. (Source: Journal of Accountancy; Jun2002, Vol. 193 Issue 6, p22-22) Edward D Graskamp, Managing Director, Fredrick W. Cook & Co. Inc. identified his set of executive compensation best practices           Elimination of “ single trigger” change in control provisions Reducing change in control gross up payments slightly if excise tax avoided Tallying termination benefits for top executives under different scenarios More even-handed document drafting (not always in executive‟s favor) Taking long-term incentives out of supplement executive retirement plans (SERPs) and severance. Executive reimbursement of personal use of corporate aircraft at net operating cost Eliminating gross-ups from perquisites Voluntary expanded proxy disclosure beyond SEC De-emphasis of competitive pay surveys Stock retention requirements until after termination. (Source: Financial Executive; Sep2005, Vol. 21 Issue 7, p10-10, 1/8p) 6. Best Practices Executive Compensation and Benefits: Action: A common executive compensation policy across all industries and corporations is not feasible. Corporations differ in their size, policies and culture; as a result some will adhere to some best practices while other will adhere to some other practices. Canadian Pacific Railway in its efforts to build independent compensation committee uses in camera meetings at committee meetings (CCGG). To adhere to the highest standards it links executive pay to performance and uses „stress test‟ pay packages. A stress test is performed to confirm that the CEO total compensation is clearly differentiated depending on various financial and market performance scenarios, against the corporation‟s multiyear plan, and against the target pay which they established for him. It also uses a policy of no reward if minimum targets are not met and also gives excess awards when performance is exceptional. At Canadian Pacific Railway management is forbidden from participating in monetization activities. The company also discloses executive compensation in its annual report, with three full years of disclosed data. Further it gives complete details of its NEO‟s employment contract and an easy to decipher break down of payments to be made to each NEO (CCGG). Cameco, a uranium company also used camera in its meetings. The company has a policy of board and committees to meet in camera without the presence of management present at those meetings (CCGG). In the year 2008 six out of seven board meeting and twenty three out of twenty four committee meetings were conducted adhering to the policy. To develop an independent view, Cameco disclosed the names of independent compensation consultants it uses. In relating pay to performance, Cameco uses an innovative matrix and it clearly explains what 4|Page
  • 6. matrix it uses. In 2009 it used adjusted net earnings, cash provided by operations before working capital changes, return on average capital and total shareholder return (CCGG). Cameco has a full disclosure policy of the salary that would need to be given if any of the executives is terminated. Under Goldman Sachs executive compensation policies, no executive officer is entitled „golden parachute payments‟ (Goldman Sachs Investor Relations). Equity based awards have not only forfeiture provisions but also has recapture provisions. Seventy five percent of after taxshares received as compensation must be retained by senior executive officers (Goldman Sachs Investor Relations). Even after retirement, equity based awards are not accelerated and transfer restrictions continue to exist. All Goldman NEO‟s have strict prohibitions and are restricted to hedge any shares of common stock 7. Summary & Conclusion: According to our analysis best compensation policy has following attributes. Primarily it shouldn‟t be excessive; secondly governance procedures should be adequate and independent. Thirdly, there should be a full disclosure and finally the compensation has to be performance based. As previously explained substantial gaps will exist between best practices and a policy a company due to macro and micro differences. . Governance Missing Link: Best Practice Remuneration Remuneration Control Activities * Source Executive Remuneration (Deloitte) As depicted in the above diagram, the missing part is an effective executive remuneration program to establish, manage and monitor alignment between the best practice governance principles which the board needs to display and company remuneration practices and control. 5|Page
  • 7. An effective executive & compensation benefits program will tie together governance and control activities and thus eliminating the gap. To sum it up, the corporations need to have sound executive compensation & benefits policy to align human resources with „SHRM‟. 6|Page
  • 8. REFERENCES "Strategic Human Resource Management." Human Resource Center. N.p., n.d. Web. 23 Jan. 2013. <management-class.co.uk/human_resource_centre/bgcha02.pdf> Govindarajan, Vijay, and Anil Gupta. "Building an Effective Global Business Team." MIT Sloan Management Review 42.4 (2001): 63-69. Web. Ebsco Host. Web 16 Jan 2013. "The General Theory of Employment, Interest and Money by John Maynard Keynes." Marxists Internet Archive. N.p., n.d. Web. 1 Jan. 2013. <http://www.marxists.org/reference/subject/economics/keynes/general-theory/ch21.htm>. "How to get motivated." Psychology Today. N.p., n.d. Web. 18 Dec. 2012. www.psychologytoday.com/basics/motivation Human Resource Management. Singapore: Cengage Learning, 2011. Print. "What Motivates Your Employees? Intrinsic vs. Extrinsic Rewards." Smarter News, Analysis & Research Communities. N.p., n.d. Web. 1 Jan. 2013. <http://www.tmcnet.com/channels/performance-management/articles/39417-what-motivatesemployees-intrinsic-vs-extrinsic-rewards.htm>. Conyon, M. (2011). Executive Compensation Consultants and CEO pay. Vanderbilt Law Review, 64:2:399, 400-500. Retrieved January 30, 2013, from <http://www.vanderbiltlawreview.org/content/articles/2011/03/Conyon-ExecutiveCompensation-Consultants-and-CEO-Pay-64-Vand.-L.-Rev.-399-2011.pdf> Development Compensation and benefits study 2011. (n.d.). Compensation and Benefits Study. Retrieved January 30, 2013, from www.dfid.gov.uk/documents/cdc-accenture-report-apr11.pdf (2005). Executive Compensation Best Practices. Financial Executive, 21(7). Retrieved January 28, 2013, from the ebsco host database. (2002). Use Best Practices in Executive Compensation Plans.. Journal of Accountacy, 193(6). Retrieved January 8, 2013, from the ebsco host database. (2003). Executive Remuneration Best Practices Principles and Guide, Deloitte & Touche, November 2003. <www.deloitte.com> Investor Relations. (n.d.). Goldman Sachs Investor Relations. Retrieved January 29, 2013, from www.goldmansachs.com/investor-relations/financials/current/proxy-statements/2012-proxystatement.pdf Best Practices in Executive Compensation Related Information 2009. (n.d.).Canadian Coalition for Good Governance. Retrieved January 15, 2013, from 7|Page
  • 9. www.ccgg.ca/site/ccgg/assets/pdf/Best_Practices_in_Executive_Compensation_Related_Informa tion_2009.pdf> 8|Page