Chapter 17
Executive Performance and
Compensation
OBJECTIVE OF MANAGEMENT COMPENSATION
 To motivate managers to exert a high level of effort to
achieve the goals set by top management.
 To provide the incentive for managers, acting autonomously,
to make decisions consistent with the goals set by top
management.
 To determine fairly the rewards earned by managers for their
effort and skill and the effectiveness of their decision making.
EXECUTIVE PERFORMANCE MEASURES AND COMPENSATION
On survey of companies reported the average annual
incentive component of compensation as follows :
1. Average annual cash and stock compensation based
on long run performance equal to 57% of current
salary, and
2. Bonuses based on short-run performance equal to 40%
of current salary.
The percentage vary widely over the
sample;
some firms
use stronger
performance incentives than others.
Employee Compensation
It is the total cash and non-cash payments that you
give to an employee in exchange for the work they
do for your business.
Two kinds of compensation:
 Cash Compensation
 Non-cash Compensation
Cash Compensation
As the term implies, cash is any type of compensation paid in the form of
a bank check or direct deposit into your bank account. Cash
compensation includes salaries and bonuses.
Non-cash Compensation
Non-cash compensation is known as fringe benefits. Fringe benefits can
help attract and retain employees and make it easier for employees to do
their jobs.
Some managers may trade off increases in salary for
improvement in title, office location, and trappings, use of expense
accounts or use of corporate country club facilities and so forth.
Designers of executive or manager’s compensation plans
emphasize three factors:
• Achievement of organization goals,
• Ease of administering the plans, and
• Ensuring that affected executives perceive the plan.
Figure 17-1:
BASES FOR BONUS COMPENSATION
Advantages and Disadvantages of Different Bonus Compensation Bases Relative to Compensation Bases Relative
to Compensation Objectives
Motivation
Right Decision
Fairness
Stock price
(+/-) Depends on whether stock and
stock are included in base pay and
bonus
(+) aligns management compensation
with shareholder interests
(+) Consistent with shareholders’
interests.
(-) Lack of controllability.
Strategic performance measures (cost,
revenue, profit and investment units)
(+) Strongly motivating if
noncontrollable factors are excluded
(+) Generally a good measure of
economic performance
(-) Typically has only a short-term focus
(-) If bonus is very high, creates an
incentive for inaccurate reporting
(+) Intuitive, clear, and easily
understood
(-) Measurement issues: differences in
accounting conventions, cost allocation
methods, facing methods and so on.
Balanced scorecard (critical success
factors)
(+) Strongly motivating if
noncontrollable factors are excluded
(+) aligns management compensation
with shareholder interests
(+) Consistent with management’s
strategy
(-) Can be subject to inaccurate
reporting of nonfinancial factors
(+) If carefully defined and measured,
critical success factors are likely to be
perceived as fair
(-) Potential measurement issues, as
above
Key: (+) positive effect on the objective
(-) negative effect on the objective
Bonus Compensation Pools

A unit based-pool- is a basis for determining a bonus according to the
performance of the manager’s unit.

A firm-wide pool- is a basis for determining the bonus available to all
managers through an amount set aside for this purpose.
Figure 17-2: Advantages and Disadvantages of Different Bonus Pools Relative to Compensation Objectives
Motivation
Right Decision
Fairness
Unit based
(+) Strong motivation for an
effective manager – the upside
potential
(-) Unmotivating for manager
for economically weaker units
(-) Provides the incentive for
individual managers not to
cooperate with and support
other units when needed for
the good of the firm.
(-) Does not separate the
performance of the unit from
the manager’s performance.
Firmwide
(+) Helps to attract and retain
good managers throughout
the firm, even in economically
weaker units
(-) Not as strongly motivating
as the unit-based pool
(+) Effort for the good of the
overall firm is rewarded –
motivates teamwork and
sharing of assets among units
(+) Separates the performance
of the manager from that of
the unit
(+) Can appear to be fairer to
shareholders and others who
are concerned that executive
pay is too high
Bonus Payments Options
Four most common payment options:
 Deferred Bonus- based on current performance (most common bonus
form)
 Current Bonus- earned currently but not paid for two or more years.
 Stock Options- confer the right to purchase stock at some future date at a
predetermined price.
 Performance shares- grant stock for achieving certain performance goals
over two years or more.
Figure 17-3:
Advantages and Disadvantages of Bonus Payment Options Relative to Compensation Objectives
Motivation
Current bonus
(+) Strong motivation for current
performance
Right Decision
(-) Short-term focus
(-) Risk averse managers avoids risky
but potentially beneficial projects
Deferred bonus
(+) Strong motivation for current
Fairness
(+/-)Depends on the clarity of the
bonus arrangement and the
consistency with which it is applied.
Same as for current bonus
Same as for current bonus
(+) Incentive to consider long-term
issues.
(+) Provides better risk incentives
than for current or deffered bonus
plans.
(+) Consistent with shareholder
interests.
(-) Uncontrollable factors affect stock
price.
Also, same as for current bonus
performance, but not as strong as for
the current bonus plan since the
reward is delayed.
Stock options
(+) Unlimited upside potential is
highly motivating
(-) Delay and uncertainty in reward
reduces motivation
Performance
Shares
Same as for stock
options
(+) Incentive to
consider longer- term
factors that affect stock
price.
(+) Consistent with the
firm’s strategy, when
critical success factors
are used.
(+) Consistent with
shareholder interests
when
earnings per share is
used
(+/-) Depends on the clarity of
the bonus arrangements and the
consistency which it
is applied.
Performance Measures at the Individual Activity Level
Performance measure is an intrigue part of every organization. Whether you
are an employee, or the owner of the company, importance of this concept is
essential for the growth of the company. Performance measurement is generally
defined as regular measurement of outcomes and results, which generates
reliable data on the effectiveness and efficiency of programs.
The performance measures at the individual activity level helps the
employees know what is expected from them. There is a direct behavior
change in this regard can be seen. Due to this system of performance
measures, there is a constant monitoring on the performance of the
employees. The employees are given feedback on their working style. It also
helps the organization to know if there is any kind of problem which can be
mended before it becomes critical. Therefore it is the firsthand knowledge
that the management can get from.
.
Importance of Performance Measures at the Individual Activity Level:
-It helps in reflecting strategies for the company.
-The performance measurement should be responsive
-It is important that there is a consistency in the values of the organization
When evaluating performance at the individual activity level two issues are
involved:
First: Designing performance measures of activities that require multiple tasks, and
Second: Designing performance measures for activities done in teams.
Performing Tasks
It is a common business practice that employers want their employees to allocate their
time and effort intelligently among the various tasks or aspects of their jobs.
For example, marketing representative sell products, provide customer support and
gather market information. Production works are responsible for both the quantity and
quality of their output.
The performance measurement should measure the different aspects of an employee's
job and to balance incentives so that all aspects are properly emphasized.
Team-based Compensation Arrangements
A team accomplishes better securities than individual
employees acting alone. Business establishments reward
individuals or team on the basis of team performance such as
achieving regional sales target by regional team.
Some criticisms on team-based compensation are:
1. Incentives for individual employees to excel are diminished, harming
overall performance and;
2. Some team members who are not productive contributors to the
team’s success nevertheless share in the team’s rewards thereby
dampening the interest and morale of the good performers.
Team-based incentive compensation
Encourages employees to work together to achieve common goals.
Individual-based incentive compensation
Rewards employees for their own performance, consistent with
responsibility accounting.
Environmental and Ethical Responsibilities
• As company’s try to achieve the performance goals of their organizations, managers
should be aware constantly of their environmental and ethical responsibilities.
Illegal practices and environmental pollutions carry heavy fines are prison offense under
the laws of many countries. Business ethics present difficulties in a single- country context,
but they pose more problems in a global context.
Ethical Behavior
• O the part of managers is paramount. They should not be tainted by ‘’created accounting’’
resulting to overstatement assets, understatement of costs. Additionally, management should
promptly and severely reprimand unethical conduct irrespective of the benefits that might
accrue to the company from such action.
A strong underlying system is important for enforcing contracts and provides the basis for
confidence in ethical dealings. Other ethical problems with bribes and differing business laws
exist. US companies that contract with overseas firms may fid themselves the target of
unfavorable publicity on use of labor.
The stories of bribery of Middle Eastern officials are legendary. In some countries, these
bribes are necessary part of doing business. Insider trading is not against the law in
Europe and it is definitely illegal in the US.
Socially responsible companies set very strict environmental goals and measure and
report their performance against them. For example, a company makes environmental
performance a line item on every employee’s salary appraisal resort. Another company
appraises employees on their part in reducing solid waste, outing emissions and
discharges and implementing environmental problems.
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