Executive Summary
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Appropriately designed executive compensation schemes can add substantial value for the firm’s shareholders.
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Base salaries should be competitive with those awarded by similar-sized firms in the industry in order to attract and retain superior top-executive talent.
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Most perquisite-type compensation is now outdated, fails to align manager–shareholder interests in any obvious way, and should be avoided.
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Annual cash bonuses should be based on measures that can’t be easily manipulated through accounting practices adopted by management.
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Long-term, equity-based compensation in the form of stock options or grants is the most effective way to harmonize the interests of senior management and shareholders.
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It is important to anticipate increased disclosure and scrutiny of executive compensation structures by the media when a particular compensation structure is being designed.
Introduction
The board of directors, and specifically the compensation committee (or remuneration committee), has the challenging task of designing a compensation structure for the chief executive officer (CEO) and other senior managers that balances their interests with those of the shareholders. The general idea is to make an executive’s pay sensitive to the value created for the firm’s shareholders. In this way, everyone shares the common goal of maximizing shareholder value.
Corporate executives can in principle be compensated in three different ways:
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base salary and perquisites, or “perks”;
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annual cash bonus;
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shares.
No one form will perfectly align the interests of senior management and shareholders. The task of designing a value-adding compensation structure is therefore about identifying the mix between these different forms of compensation that best incentivizes senior management to create value for the shareholders.
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