Key highlights
- Executive compensation refers to the package of rewards that top-level executives receive for their work, including base salary, bonuses, stock options, and other forms of equity ownership.
- The compensation gap between leading executives and the typical worker continues to grow wider year on year.
- In recent years, executive compensation has become increasingly complex, with a greater emphasis on performance-based pay and long-term incentives.
- To ensure that executive compensation aligns with good corporate governance practices, organizations should adopt best practices, review compensation plans, engage with shareholders, enhance board oversight, and provide transparency.
Compensation has always been a point of concern in employee/employer relationships, with executive compensation even more so. While the landscape of executive compensation has evolved significantly over the past few decades, with implications for corporate governance, it, however, continues to be dogged by controversy. Essentially, the compensation gap between leading executives and the typical worker continues to grow wider year on year.
The Economic Policy Institute (EPI) report estimates that “in 2020, CEOs of the top 350 firms in the U.S. made $24.2 million, on average — 351 times more than a typical worker.”
In exploring this topic we’ll consider a brief overview of what executive compensation is, how it has changed over time and the steps an organisation can take to ensure that executive compensation aligns with good corporate governance practices.
Executive compensation refers to the package of rewards that top-level executives receive for their work. These rewards can take many forms, including base salary, bonuses, stock options, and other forms of equity ownership.
Overall, executive compensation is intended to attract, retain, and motivate talented executives to lead the company and drive its success, while also aligning their interests with those of the company and its stakeholders.
In recent years, executive compensation has become increasingly complex, with a greater emphasis on performance-based pay and long-term incentives.
One of the key reasons for this shift in executive compensation is the increasing focus on shareholder value. As companies have become more shareholder-focused, they have sought to align the interests of their executives with those of their shareholders. This has led to a greater emphasis on performance-based pay, as companies seek to incentivize their executives to drive growth and profitability.
However, this emphasis on performance-based pay has not been without controversy. Some critics argue that it can encourage short-term thinking and unethical behaviour, as executives may be incentivized to prioritize short-term gains over long-term sustainability. Others have raised concerns about the widening gap between executive pay and worker pay, which they argue can lead to social and economic inequality.
Despite these concerns, the trend towards performance-based pay shows no signs of slowing down. Many companies are now exploring new ways to incentivize their executives, such as using environmental, social, and governance (ESG) metrics to determine executive compensation.
This shift towards ESG-based compensation is reflected in a quote by Paul Polman, former CEO of Unilever, who said, “There’s a growing recognition that we need to focus more on long-term value creation and broader stakeholder engagement, and executive compensation is a critical lever in achieving this.”
Another key development in executive compensation is the rise of say-on-pay votes. Say-on-pay votes allow shareholders to vote on executive compensation packages, which can serve as a powerful tool for promoting good governance. According to the Council of Institutional Investors, “Say-on-pay votes are an important accountability mechanism that helps ensure that executive pay is aligned with company performance and shareholder value.”
Despite the growing emphasis on performance-based pay and say-on-pay votes, some experts argue that more needs to be done to ensure that executive compensation is aligned with long-term sustainability and the interests of all stakeholders. As Lynn Stout, professor of corporate and business law at Cornell University, argues, “The best way to reduce the short-term orientation of executive compensation would be to focus on creating long-term performance measures that account for the broader societal and environmental impacts of the firm.”
The controversy surrounding executive compensation and corporate governance can be complex and challenging to address. However, there are several steps an organization can take to resolve the controversy and ensure that executive compensation aligns with good corporate governance practices. Here are some suggestions:
Adopt best practices
The organisation should adopt best practices for executive compensation that are in line with industry norms and generally accepted corporate governance principles. This can include setting clear and reasonable performance targets, conducting regular reviews of compensation packages, and providing transparency about executive compensation.
Review compensation plans
The organisation should review its compensation plans and ensure that they align with the organisation’s goals, values, and long-term strategy. This can include reviewing the ratio of executive compensation to that of other employees, and ensuring that the compensation packages incentivize long-term performance and align with shareholder interests.
Engage with shareholders
The organisation would do well to engage with its shareholders and seek their input on executive compensation practices. To achieve this, it can include conducting regular shareholder meetings and communicating with shareholders about compensation decisions.
Enhance board oversight
Every organisation should enhance its board’s oversight of executive compensation by appointing independent directors, establishing a compensation committee, and ensuring that the board is fully informed about the organization’s compensation practices.
Provide transparency
In addition, the organisation should provide transparency about its executive compensation practices by publicly disclosing the details of its compensation packages and explaining the rationale behind its decisions. This can help to build trust with stakeholders and reduce the risk of controversy and negative publicity.
Evidently, the landscape of executive compensation has evolved significantly in recent years, with a growing emphasis on performance-based pay and ESG metrics. While these changes have led to concerns about short-term thinking and inequality, they also offer opportunities for promoting good governance and long-term sustainability. As the business world continues to evolve, it will be important to monitor these trends and ensure that executive compensation is aligned with the interests of all stakeholders.
Resolving the controversy surrounding executive compensation and corporate governance requires a comprehensive approach that addresses the concerns of all stakeholders, ensures alignment with the organisation’s values and goals, and promotes transparency and accountability.
Chioma Mordi is the MD/CEO
About The Society for Corporate Governance Nigeria
SCGN is a registered not-for-profit organisation committed to the development of corporate governance best practices in Nigeria. Today, the Society is the foremost institution committed to the development and promotion of corporate governance best practices in Nigeria. cmordi@corpgovnigeria.org