In 1976, a paper that appeared in Journal of Financial Economics by noted American Economist Michael Jensen and William H. Meckling named 'Theory of the firms: Managerial behaviour, agency cost and ownership structure' is credited to boost the thought of performance based pay or more closer - incentive like stock options. It's based on the idea that people respond to financial incentives, so if you reward them monetarily when they do right things, better results follow. There is however limitations being pointed out too i.e. it may work well for routine tasks but may prove less successful if the job involves learning and creativity, which are hallmarks and pre-requisites of today's entrepreneurial professionals faced with vast and big changes in a multifaceted business environment. Research also shows that an executive performance worsens when they have certain explicit goals to hit resulting in frauds or discrepancies. They are better when they are free to work to do what they like doing, develop a particular competence, acquiring a new set of skills or mastering a new situation.
Very recently a human capital and management consulting services firm conducted a CEO compensation survey of over 380 companies in India revealing that half of the CEO pays are linked to performance, that only 50 per cent of the CEOs take a fixed salary, the rest are happy receiving annual bonuses or long term incentives like stock options and it is more likely that the former half of the CEO population will shrink further following global benchmarks regarding pay and rewards. As in terms of salary increment at CEO and CXO levels, the survey shows a marginal drop in fixed pay increase to 9.5 per cent in 2015-16 from 9.7 per cent last year.
As per BSE, the CEOs of many listed Indian companies are still paid lesser than their global counterparts while there is a shift being witnessed to bring this to par. However, the divide or gap between the pay scales of the next level of senior executives still remains big and a talent retention and management worry.
Globally too, while the CEOs are believed to take lesser cash in hand or basic salary component, the variables of bonuses and stock options doesn't help reduce the chasm. In USA, as per industry estimates, stock options account more than half of the CEO's compensation and 30 per cent of senior operating manager pay. Chief executive officers of S&P 500 companies on average made 335 times more money than U.S. rank-and-file workers last year according to a recent union study. This is after a fall last year due to the financial crisis, as weaker corporate performance also slowed the cash bonuses. In the United States, the stock options impact personal tax liability, although taxed at federal income rates, they are exempt from some portions of payroll taxes used to fund social security and medical care. Back at home, Vishal Sikka of Infosys took home an annual salary package of $7.45 million for 2015-16 including increased stock options as part of broader strategy to retain key executives or reward the rainmakers. And this is to bring at par with CEOs of other competing global IT giants like US based Cognizant Technology.
It is known that Apple founder Steve Jobs had adopted the popular dollar-a-year salary when he returned to the firm in 1997 and maintained it through his 2011 resignation. Jobs received limited bonuses and perks but what he wasn't making in base salary he made up for in other ways, including the ownership of 5.5 million Apple shares and 138 million Disney shares paying rich dividends. HP's dollar salary agreement with Meg Whitman was to undergo a change later, sooner. Upon joining the company in 2011, her initial salary was at $1 per year, her pay stood at $1.5 million by 2014, a reward for turning around things. In 2010-11 Oracle Founder and CEO Larry Ellison made only $1 in salary, but earned over $77 million in other forms of compensation.
Stock options started to become important tool for wealth creation for both shareholders and professional CEOs as they are counted as non-cash corporate expense attributing positively in a company's income statement and distribution options becoming more transparent to shareholders. From a long term perspective, it is considered as a talent retaining tool and for the top executive money actually from stock ownership plans could be very different (strike price) from the worth of these options at the time of grant.
However, the critiques of stock options think that the tool is vulnerable and open to maladies when it is used to inflate stock prices before the options are exercised. Stock options also incentivize executives to engage in risk-seeking behaviour that can lead to catastrophic corporate failure if in excess or unchecked. Executives argue that remuneration through stock instead of salary ties management performance to their financial benefits. The assumption is that stock prices will reflect the actual value of a company, which reflect the management performance of the company. Detractors argue that this incentive may drive short-term planning over long-term planning. During the period of bull market runs, average performance also appears superior and vice versa. With much of them pay on stocks, executive focus remains largely on maximizing shareholders returns and not long term growth. Measuring performance therefore appears one-dimensional open. There is also some concern that employees who are not co-owners of the organization and hold employee stock ownership will be presumably less clear of the line of sight and less inclined to comprehend and embrace it. He may not fully understand precisely how to contribute to the organizations' strategic goals and what his or her actual impact will be on the final outcome.
Stock options signify the quantum of variable pay and it may completely fail to impress in cases where it is determined less by nature of the industry and more by the impact on the business in a particular industry of variables that are either in the control of the executive or doors that are beyond his/her control. Therefore, in sectors such as infrastructure, large capital goods and mining where the intervention of the government policies and regulation is seemingly high, the total proportion of variable pay usually should not go above 20 to 30 per cent.
Shareholders have become increasingly vocal over executive salaries and bonuses amid slumping earnings and lower commodity prices. Shell Chief Executive Ben van Beurden's 2015 remuneration fell 8 percent to 5.135 million euros ($5.63 million) last year, when the company's revenue dropped sharply due to low oil prices. BP's shareholders voted against Chief Executive Bob Dudley's $20 million pay deal for 2015, after it recorded a record annual loss.
While William Kahn's theory of engagement and disengagement at work emphasised that people are only willing to devote their 'energy where it will be appreciated' and rewards and pay rise is certainly a good way to demonstrate that. However he also explained that rewards limited to performance start to fade away as they will sooner or later cease to motivate, they seem more punishing than rewarding affecting relationships and also discourage risk taking and reasoning. In a case like that what drives the promoter or founder CEO is only the passion that is far larger than the dynamics of economics and they will know how to reward or punish themselves for the sake of goodwill hunting or business philanthropy.
Brin and Page, Google's cofounders asked their base salaries be reduced to $1 per year in 2004. Since then, Google's compensation committee has offered them market-competitive salaries annually, which they continue to decline. While they also forgo cash bonuses based on their individual and company performance and do not hold any stock options, Google stock units, or other contingent stock rights, Page is currently worth an estimated $34.9 billion and Brin is worth an estimated $34.3 billion. According to Tesla Motors' SEC filings, Musk, whose net worth is valued at an estimated $13 billion, was required by California law to be paid a minimum wage of $37,000 in fiscal year 2015 that Musk has never accepted and currently does not accept his salary. He also declines receiving a bonus, stock awards, option awards, or any other compensation. The Co-CEOs of Chipotle Mexican Grill Inc., Monty Moran and Steve Ells, lost their bonuses last year after an illness outbreak at its restaurant sickened customers and sent share price tumbling. Total pay for the two CEOs fell by more than 50 per cent each. N.R. Narayana Murthy, who had given the final nod to Sikka's recruitment, was drawing Rs 1 per annum as he had earlier stipulated a token salary only post his retirement in June 2013 and took charge as executive chairman again.
Shareholders along with compensation committees are today empowered to decide CEO pays to fix a system that leads to outsized executive compensation as the role of 'advisory' is also shifting to 'strategic' but it may still be slightly early to say that the salaries in India can touch the scale of the world's highest paid non promoter or founder CEO, for that the Indian companies have to be as big as Microsoft. Did I hear someone saying - let us compare apples to apples!
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