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Compensation structures for the better alignment of management and shareholder interests

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  1. Introduction
    1. Topic Introduction
    2. Importance of issue
    3. Clarification of question and specific model company
  2. Compensation options
    1. Guaranteed salary â€" Benefits and downsides
    2. Bonuses â€" Benefits and downsides
    3. Stock options â€" Benefits and downsides
    4. Stock appreaciation rights â€" Benefits and downsides
    5. Restricted stock â€" Benefits and downsides
  3. Academic research
    1. Presentation of academic research on topic
  4. Suggested compensation guidelines
  5. Conclusion

In recent years there has been much controversy surrounding the supposed ?high' levels of executive compensation in large publicly traded firms. CEO pay packages, measured as multiples of average non-corporate worker pay, reached a peak of 525 times in 2000. Pay packages have also grown far more complex as bewildering combinations of stock, options, deferred compensation, bonuses, golden handshakes and parachutes have been employed. The goal, however, of all these tools is clear: it is to attract and retain top management talent whilst aligning their interests with owners in the pursuit of maximum shareholder returns. This paper will discuss the common forms of compensation available for a company and the advantages and disadvantages of each compensation option. We will then analyze the existing academic literature on the topic of executive pay and alignment of interests. Finally, we will propose what we believe to be the ideal mix of compensation vehicles that balance the interests of shareholders and management.

[...] The only incentive to perform is the risk of being removed from the position, which is at best a negative reinforcement and does not align management and shareholder interests at all. Bonuses Benefits and Downsides Bonuses are variable payments based upon achievement of certain success criteria during a single year's performance. Performance in this instance is most commonly defined as accounting profits, though EPS, ROA and ROE are also used on occasion. This method of compensation aligns management and owner interests in a simple manner whereby if certain performance thresholds are reached, pre-specified bonus amounts are paid out. [...]

[...] We feel strongly that based upon the empirical studies, the current stock market conditions, and the wider calls for CEO/top management pay accountability by shareholders, the best compensation structure for top management is one that encompasses a of incentives, a structure which utilizes cash (salary and annual bonus), as well as stock grants. However, the caveat here is that such a structure is based upon accounting- based measurements as well as market-based measurements. The primary reason for this ?mixed approach? is to take advantage of the way in which stock ownership provides a great incentive for top management, while also carefully setting specific accounting goals which prevent manipulation and reckless short-term and long-term senior management decisions in the name of self-enrichment but at the expense of shareholder value. [...]

[...] Management Compensation and Shareholder Returns.? Journal of Management Studies. Volume 36, Issue January. Rajaram Veliyath's article discusses a study he performed primarily investigating the linkage between cash compensation and stock options granted to top management with the market return of those companies' stocks. Mr. Veliyath characterizes the various forms of compensation along two dimensions: one spanning fixed to variable and the other current to defer. Fixed and current compensation - a salary - provides very little direct incentive for a manager to perform in the shareholders' best interests. [...]

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