Examining the results of adopting specific components of an executive compensation package is significant. Analysis is important as it aids the public in evaluating the performance of the CEO relative to changes in firm performance.
This link between pay and performance is addressed by examining the relationship between adoption of a performance-based compensation component, performance plans, and improved firm performance.
Controversy has been prevalent for many years surrounding the relationship between executive pay and firm performance. Public interest has fueled, and often creates, many of the debates regarding levels of executive pay. Studies examining the relationship between performance-based compensation components and improved firm performance as measured using accounting variables have been conflicting as well. Some studies have shown that accounting-based compensation components motivate managers to make decisions that increase their own wealth but do not improve firm performance (Lobingier, 2000, p288)
“Despite the large numbers, one analyst said CEO pay increases are smaller than they used to be and are more in line with pay increases for most employees, around 3 percent to 5 percent annually.” (Burn , 1997, p8) However that is hard to accept when CEOs are increasingly being paid in stock options in addition to compensation as a way to link pay to corporate performance. When exercised at the right time, stock options nets executive astronomical sums.
For instance, Jeffrey R. Immelt, Chief Executive Officer General Electric Company In 2005, Jeffrey R. Immelt was compensated $15,412,870 including stock option grants from General Electric Company. Similarly, Edward E. Whitacre, Chief Executive Officer AT&T Inc. in 2005 was paid $17,181,223 including stock option grants from AT&T Inc...
Though financial CEOs were paid the most, salaries for diversified service executives increased by 7.8 percent to $481,000 compared with the year before. Manufacturing-executive pay jumped 6.8 percent to $635,000, and telecommunications executive pay rose 5.9 percent to $820,000. (AFLCIO, 2007)
Investment decisions are influenced by growth opportunities and free cash flow environments, therefore corporate executive leadership promotes the idea that effective leaders adopt a long-term perspective, allegedly that is strategic and visionary, however it omits the financial aspect. Our results suggest that CEOs' pay-for-performance incentives are related to their investment decisions relating to future performance. This is not surprising as salary and bonus are based on short-term accounting measures of performance and, therefore, focus managerial attention on short-term performance.
Financial packages are justified via operating in multiple lines of business that reduce information between principals and CEOs. This could alter the incentive contract given the CEO, with ambiguous effects on compensation structure and level. However, studies have failed to detect any significant differences between diversified and undiversified firms in the pay-for-performance relationship. (Rose, 1997, p500)
