Typical CEO salary: How is it decided?
The position of the CEO is usually the top post in the hierarchy of command in any company. Being at the top of company’s chain of command, the CEO has the key responsibilities that steer the company in the right direction. Some of the vital roles of a CEO include forming and communicating enterprise’s strategic decision. While the other employees of the company help in shaping the strategic vision the CEO must provide clear guidance on how to achieve the vision. Besides the CEO forms a bridge of communication between all stakeholders in an organization. The CEO is responsible for overseeing the overall performance of an organization to meet the demanding interests of the stakeholders.
For a CEO to perform accordingly, there is always a need for ensuring he or she gets a fair compensation. The salary of a CEO can be determined in various ways. Most companies use the same strategies to come up with a compensation plan for their CEOs. Here are the options a company can adopt in paying its Chief Executive Officer.
Risks and Reward
This basically means that his or her performance determines the executive’s compensation. The board can decide to use compensation contracts to align the company’s CEO’s actions with company’s performance. The idea is to pay for value added whereby if the company is doing well the CEO gets a good pay but if the company starts failing the CEO’s pay declines with poor performance. While it sounds like a great idea to pay the executive depending on the performance level, this may hinder the CEO from taking huge risks which could either rocket the companies level or drop the profits. Therefore, most CEOs compensated using reward/risk model tend to operate on the safe margin to avoid losing their earnings. However, most CEO who want to make a difference and build a reputation tend to work hard so as to boost their income. The CEO will also want to raise his or her earning by performing better so that he or she can have a bargaining advantage when being poached by other organization. For a company to attract good leaders they have to offer better pay than the executive is being paid currently.
In most companies, you will notice the Chief Executive Officer is normally paid a base salary. In fact, it is easy to find the ranking of the top highest CEOs in the world since their salaries are easily determined. This means that if the company’s board decide that the CEO will be paid $2 million that will be his or her pay whether the company is profitable or not. A CEO, who gets paid a base salary does not get any significant reward no matter how well the CEO performs; however, he or she can get an appreciation reward in case of extraordinary performance. Huge base salary, however, may not be a wise decision since the CEO does not have to work hard to earn extra income.
The board may also decide that the executive will be getting a bonus at the end of the year depending on the stated requirements. However, bonuses sometimes are tricky since they may contain a base salary in disguise. For instance, a CEO who earns a salary of $2 million can also receive a bonus of $800000. If it is stated that $500000 doesn’t depend on performance, then that is a base salary in disguise which translates the total base salary to $2.5 million. Bonuses that vary with performance are also tricky, but they are viewed to be the best since the CEO will have to work hard to get higher pay. Bonuses help to motivate CEOs work hard and think smart.
There are several ways of gauging the company’s performance which include return on investment, profits, as well as share appreciation. However, using simple metrics to determine how much to pay the CEO depending on company’s performance may lead to unfair results. The CEO may be penalized for one time unfavorable event such as adverse market results or enjoy the fruits of a previous CEO whose long-term goals are being realized currently.
Stock options are meant to merge the shareholders’ interest with the CEO interest. However, share options have some limitation since they can be skewed. CEOs can make fortunes where the share value goes up but in case the share value drops the shareholders lose while the CEOs are not hurt. In fact, it gets worse where a company allows a CEO to swap old share option with new shares if the company’s share drops in value. The CEO may also be motivated to focus on short-term goals where share price monitoring is kept in money value. The CEO can also doctor the numbers to ensure that the short-term goals are met therefore ruining the overall long-term goal of the company. All this brought together it breaks the link between the shareholders and CEO’s interest.
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Financial studies show that common stock ownership facilitates better performance. Therefore, The best way to ensure that the CEO performance is driven by shareholders best interest is by having them own shares, not options. If the CEO has an interest in the company, he or she will treat the company as his or her business. The idea of stock ownership is to give a CEO a bonus whereby he or she is obliged to use it to buy shares. The advantage of share ownership over option is that in share ownership if the company loses value the CEO also loses but in share option if the company loses value the CEO has nothing to lose.
Most companies almost use almost the same strategies in determining their CEO salary due to various factors such as fair compensation and networking. Networking comes in where one or more board members are on several company boards. Therefore, they may use the strategy they used to come up with one company CEO’s pay to determine the pay of another company’s CEO pay. Fair pay also applies where the CEO both the base salary and bonuses thus being motivated to work harder and smarter. The CEO salary should also show that he or she is appreciated since he or she holds the most critical position in the entire organization.