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Executive Compensation - How Do You Figure It?

In one of my classes, the subject of how much high-level executives are paid came up, and the professor asked if we could come up with an equation to define how an executive should be paid. I came up with the following equation:

XC = (N){(Xf [(3Sc(Fp-Pp)) + (0.5(T + (V*Ex)]))2R} - (CP*CE)

where

XC = Executive Compensation

Xf = Standard executive compensation for the industry stated as a multiplier

Sc = Scale of company

T = Duration of contract, including non-competition restrictions

V = Visibility

Ex = Expectations

R = Risk

and

CP = Contractual Penalties

CE = Critical Events (such as arrests, SEC investigations, bankruptcies, and the like)

N = a negating factor voiding the contract (N would equal either 0 or 1)

This equation is based on the assumption that I am attempting to describe executive compensation as it should be developed.

My initial equation was based on the fact that the modern executive compensation generally starts with the base salary, and adds bonuses and perks to it. In the exercise here, to leave the compensation one which attracts a good executive and which rewards superior performance, but also to deter dishonest, lazy or simply incompetent executives, we must add penalties for certain events. In my initial equation, I dumped those into CP or contract penalties, but given the habit of some committees to take short cuts, maybe that is too simple. So I would add the variable CE or Critical Events, such as Bankruptcies, SEC investigations, as a multiplier of CP. A CEO who likes to have expensive lunches is one thing, but one who hires spies to find out what board members are doing (as happened at HP) is of another degree entirely. I would also take a page from the professional sports leagues, and throw in a negation clause, I will call it N, value 0 or 1, which means that under certain circumstances the executive gets nothing at all, although I have to say it would be hard to get someone to sign such a deal, unless the conditions were very carefully defined and unlikely except for egregious conduct (did I mention Michael Vick?).

Anyone else like to play this game?


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Comments (5)

Considering that executives... (Below threshold)

Considering that executives are compensated, rewarded, etc. by their Boards, which are made up of people exactly like themselves, nothing will change. After all, if you end the gravy train of one CEO, he/she might make sure that, by calling in a chit with a colleague that sits on your Board, you get similarly dissed. And there aren't enough investors who are willing (or able) to take the time to force a Board to discipline a wayward or underperforming Exec.

Either way, an Exec is in a unique situation, one where they are immune from the consequences of their actions, and are obscenely compensated regardless of performance.

Well langtry, that's certai... (Below threshold)

Well langtry, that's certainly a vivid caricature. Let me ask you, how does someone get onto the board of a major corporation?

Next, what are the requisite qualifications of a potential CEO for a Fortune 500 company?

And third, we hear all the time about this company or that canning their CEO (note that board members are far less discarded), from HP to Home Depot. So why do you drop CEOs into the same bucket as other executives?

Just curious ...

;-)

Fp=?Pp=?... (Below threshold)
CharlieDontSurf:

Fp=?
Pp=?

Sorry. (Fp-Pp) is Future p... (Below threshold)

Sorry. (Fp-Pp) is Future performance less Present performance.

Other factors come into pla... (Below threshold)

Other factors come into play. Congress, reacting to populist fervor over executive compensation, decreed that any salary over $1 million per year would no longer be deductible as a business expense. The stated intention at the time was to force companies to shift more of their executive pay into stock and stock options so that the compensation would more closely track performance.

Ah, but just as no one expects the Spanish Inquisition, no one intends to activate the Law of Unintended Consequences. CEOs began, under the new comp regime, to take actions which tended to boost the stock price in the shorter term (coincidentally matching the term of their stock options) instead of ensuring their companies' longer-term health. Go figure . . .

Naturally, not every CEO allowed his personal financial interests to trump what was best for his company. Some, however, went well beyond it by taking steps to artificially and even fraudulently inflate their stocks' prices. Many of these were caught and prosecuted, but undoubtedly some managed to escape with the loot.

The moral of the story is: "What the hell is Congress doing setting rules for what private companies may pay their executives anyway?"

If the income of individuals who employ thousands and serve millions' economic needs can be "obscene," then why doesn't Congress limit the incomes of mere entertainers, the social benefits of whose "labors" are difficult to quantify?




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