Executive Compensation: Six Questions that Need Answering

Abstract

at the beginning of an annual pay cycle.Annual bonus is defined as cash compensation that is determined at the end of an annual pay cycle and is based on only one-year's worth of performance information.Benefits are the company's cost to provide retirement income, health care, and other services, evaluated on an annualized basis.Long-term compensation is the annualized present value of any cash, or cash-equivalent compensation that is based on outcomes measured over periods longer than one year.2 The data in this, and subsequent figures, have been updated for this paper and are available from the authors on request or from the web site mentioned in the acknowledgements.Not surprisingly, figure 1 shows that US CEOs receive compensation levels that appear out of line with the other OECD countries, although figure 2 shows that this is not the case for human resource directors.3 We will see, however, that the high compensation received by US CEOs is composed of several complex instruments that require a more detailed analysis in order to understand US compensation systems.Although figure 1 shows that US CEOs receive higher levels of pay than those in other OECD countries, comparisons along other dimensions are also useful.Kaplan (1994) compares Japanese management practices to those in the US.He finds that the sensitivities of cash compensation and probability of turnover to market returns are not statistically different across the two countries.One difference is that financial institutions take a more active role in corporate governance in Japan, particularly following negative earnings.This may explain why turnover and compensation are more responsive to negative earnings in Japan.Rather than relying on monitoring from the board of directors, the interests of US CEOs and shareholders are aligned through higher stock ownership.Overall, however, Kaplan's conclusion is that the US and Japanese systems are quite similar. The Basic Structure of Contingent Executive CompensationThe system has doled out rich rewards-but it can and does impose hefty penalties on those who don't perform.More than ever, the boss is likely to lose his job and his perks when he doesn't deliver the profits shareholders expect.(Business Week, April 22, 1996, pp.102.) comparative data for native executives (not foreign nationals) when one looks at very large companies because there are relatively few of them in most OECD countries.2 Long-term compensation includes stock options (the right to purchase company stock at a given price), restricted stock (stock that cannot be sold for some specified period of time), performance share plans (formulabased stock compensation), and cash equivalents of all of the above.3 A figure showing that US manufacturing operatives receive compensation levels similar to those in other OECD countries is included in this working paper and on the web site mentioned in the acknowledgements.Figures that use real exchange rates rather than purchasing power parity rates are also included in this working paper.Real exchange rates are useful to compare differences in employer costs across countries.See the supplementary figures in the Data Appendix to this working paper.