The WorldatWork Handbook of Compensation, Benefits & Total Rewards: A Comprehensive Guide for HR Professionals

Chapter 13. Executive Compensation: An Introduction

A well-designed executive compensation plan is important because it rewards both executives and shareholders, whereas a poorly designed one wastes corporate resources without motivating the executive. At the extreme, a poorly designed incentive system can cause the executive to take actions that reduce shareholder value—for example, cutting back on long-term profitable investments (a.k.a. positive net present value projects) to increase current compensation.

Research has shown that when the corporation is performing poorly, shareholder proposals on executive compensation are likely to be made (Thomas and Martin 1999), with most of these proposals calling for limits on amounts paid to executives. Other research shows that stock prices react positively to initiation and/or amendment of compensation plans (Morgan and Poulsen 2000; Brickley, Bhagat, and Lease 1985; Tehranian and Waegelein 1985), indicating that shareholders believe the plans will motivate executives to increase shareholder value.^[1]

Executive compensation is also important because it affects compensation levels and composition throughout the organization (Gomez-Mejia 1994). It affects the level of compensation because lower-management compensation is often a function of upper-management compensation, and it affects the composition of their compensation package because the same goals may be applied as well.

Underlying the need for, and importance of, executive compensation ...