CEO pay at the crossroads of Wall Street and Main: Toward the strategic design of executive compensation.

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1) My understanding of the paper

Executive compensation has generated controversy related between the executive pay and the firm performance.

The lack of relationship has led to calls from for reform from various organizations (stakeholders, shareholders, etc.)

Linking compensation to objectives and performance measures emphasises short term profitability at the expense of the long term viability.

The base of evaluation market v/s accounting might be different in the way of evaluating performance strategically.

Combined ownership and control the incentive is not a threat because the manager is at the same time the owner. The principle of profit maximization is assumed to be sufficient to motivate and guide managers.

The separation of ownership and control are resumed in that the professional managers hold a small or in some cases none of the firm's equity.

Pay for performance is a double edged sword, it has been found that CEO wealth changes $.5 for every $1.000 in shareholders wealth. The level of executive's compensation is driven by firm size than by performance.

The governance problems will result in compensations based in high fixed salaries.

Performance based strategy will be based in accounting incentives and stock market incentive, both have been criticized for the emphasis on the short term and the effect on the decision horizons.

The use of balance scorecard that adds alternative criteria to evaluate has been used lately, the problem is the difficult and cost to use this system.

Accounting based compensation

The problem with accounting is that it reflects the past and not the impact on future decision, so using accounting is only effective in firms where the cash flow tends to be stable. Accounting is also useful where cost containments and operational efficiency are crucial.

Also the reason that accounting returns are allocable to lines of business they might be useful in diversified or multi-business firms.

Accounting will be useful in companies that pursue the following strategies

- cost leadership strategies

- slow and standard cycle resource profiles (protected by patents, regulations, or mass production technology, etc.)

- unrelated diversification strategies (the use of intense financial control)

- highly leveraged capital structures

Stock market based compensation

They generate a managerial myopia due to the pressure of the investors and other in the decision-making.

If investment in R&D will reflect in share price then the utilization of stock market incentives can be used.

Using market-based incentives is useful when the following strategies are used

- differentiation (competitive advantage by charging a premium price)

- fast cycle resource profile (rapid technological changes and innovation)

- high growth industries (rapid demand driven growth)

- related diversification strategies ((business units that operate in similar industries)

- restructuring strategies (spin offs)

Differed compensation and firm strategies

This is basically tomorrow payoff for today's performance. It has advantages hat it postpones the payment of taxes. They postpone income during the initial stages for a increase as there carers progress.

Stock operation serves as an example.

The firm strategy must be considered especially when the long terms and well-being are part of the company's strategy.

A combination of these schemes might be used but the most important thing to do is to identify the company's strategy.

) My local view

The models explained above are somehow limited locally due to existing law. Basically a major share holder cant received a salary (fixed or variable income) if he is working as an executive or manager of the company regardless the time dedicated to the job (full time or partial). The law clearly states that he can make anticipated withdrawals against profit but no salary is allowed.

In some cases this can be solved by legal structures that can only be agreed when the concentration of the ownership of the company is limited to a close circle. Also there are some cases where there are preferred shares that allow to control.

It is also not allowed under the existing law to give shares to someone and after they leave the company to return the shares.

A combination of accounting ands stock based compensation in line with the company's objectives is used manly in international companies or big ones. In the medium to small ones what is normally found is a fix salary with a bonus linked to accounting results.

The above is also related with the local culture that is clearly adverse to risk, so they prefer to have a fixed salary and be certain that it will be paid monthly and that the goals are clearly set.

Also restrictions imposed by law, the rigidity of the labour law (where a big effort in order to make it more flexible is being done) play against variable structures (the indemnity of firing someone will be calculated on the past months salaries).

) My experience

In our office (a reinsurance broker) we have people of different educational levels and cultures working.

Being a small office with 8 people working income and production is in everyone's mind so a good year is know by all of the office member as well as bad one.

There are no secrets regarding income as well as the offices profit.

Regarding salaries for the admin's we pay high above market (more than 50%) with lots of additional benefits and we did include a variable part (that was not asked by them) in order to compensate them for the good company's result.

Our general manager (also the local owner) has a small fixed salary (10% of his income) and his major income is out of the company's results. Due to the nature of the business the income is deferred in some cases in a year so a long term view is necessary.

As a result of that we are one of the few brokers with a stable base of client and our growth has been consistent over time increasing the owners profit with a stable and steady growth.

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