AUSTRALIAN LAW

Australian Law

Australian Law

Question One: Executive Remuneration

Amid the intensified media and political scrutiny of executive pay, analysts have tried to answer the question of why executive compensation has risen so much faster than that of the average worker. Most agree that the chief factor has been the change in the way that most CEOs are now paid. Until the 1980s, managers were largely paid like most other workers, with a flat yearly salary plus annual bonuses. The executive generally received the same pay whether the company that he or she managed performed well or poorly.

During the 1980s, many of those payment plans for executives were abandoned in the face of criticism that they created poor incentives for executives and that they encouraged inefficiency. Critics argued that the principal job of an executive is to produce profitable returns for the company's stockholders. But an executive who earns a flat salary, they reasoned, has little to gain or lose if the company's stock rises or falls. As a result, the executive may be less likely to consider whether his or her business decisions could endanger the long-term viability of the company--and the company stock.

Some analysts suggest that some of the notoriously faulty business decisions that were made during the 1980s, including a rash of poorly planned mergers and takeovers that left some previously healthy companies saddled with debt, resulted partly because executives were not personally affected by their business decisions. Other poor business trends that could have been avoided, some observers say, included the hiring of excess personnel during the decade, which ultimately led to the downsizing era of the 1990s (Bebchuk & Fried 2004, 89 - 115).

As an alternative to flat salaries, corporate boards began to embrace pay-for-performance plans, which tie an executive's compensation to his or her overall success at making a company profitable. Usually, such plans give executives a base salary plus stock options--the opportunity to purchase shares of company stock at a fixed price. The executive is required to cash in those stocks within a certain time limit, such as three to six years. If the executive has performed well and has adequately increased the value of the company's stock during that time, he or she stands to make a substantial profit when those stocks are cashed in. If the stock has fallen, the executive receives the price at which the stock was originally purchased.

Stock options have been widely praised for giving executives a greater incentive to increase company productivity. Proponents contend that the payment schemes have become so popular among businesses because they better align the interests of executives with the interests of company stockholders. Pay consultant Pearl Meyer estimates that in 1996, approximately 36% of executive compensation consisted of salary plus stock options, and another 43% consisted of salary and either long term or short term bonuses, which are also usually based on performance (Shields & Brien 2003, 69 - 170).

Analysts also cite several other factors that have pushed up executive pay in recent ...