Executive compensation : excessive?
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__ executive compensation __
short-term incentives, bonuses,long-term incentive plans (LTIP), employee benefits, perquisites, or perks : A reinterpretation is recommended, considering top executives possibly as "temporary hidden shareholders".
| This text had been created late 2008 during the financial crisis. Later updates are not intended. The text is maintained here because of general permanent interest.
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Temporary shareholder?
A general explanation concept for high executive compensation.
- The general explanation for "excessive" executive compensation is here suggested as follows: These top executives are "temporary shareholders" of these companies.
- This interpretation apparently conforms to the real typical behaviour of the executives concerned and of their shareholders.
- This interpretation would supply satisfactory results for all stated problems with high executive compensation forms. It would enable the application of an already existing legal framework for shareholders with dominating influence. This is explaned in detail later in this text.
Why did "excessive" compensation develop progressively during the last decades?
- Shareholder typically do not any more properly control the executives und their compensation.
- This is due to the fact that most shares are not any more owned by personal investors with business experience. In our time, most shares are owned by institutional investors. There are 2 major groups:
- (1) Investors who manage funds for security savings, especially for retirement savings. Modern industrialized and service-oriented countries have a significant need in savings for retirement. Most of the personal investors do not have enough knowledge for proper investment decisions. Their money investment decisions are based on trusting in names and credibility, and are also based on taxation preferences. Most of these personal investors are unable to take part in controlling or supervising companies.
- (2) Group 2 of Investors: Those who manage funds related to huge capital flows (energy supply - like Arabic countries - , currency exchange constellations - like China - , tax haven services - like Switzerland).
- These institutional investors do not want do deal with control and optimization of companies. They just want a rating value by some rating agency, to justify in a formal legal manner their investment decision. They want that the company top executives deal with everything else: They want that the top executives behave like major shareholders.
- Finally, these fund managers have also become some kind of "hidden shareholders" of their respective financial businesses. Therefore they fully agree with this role for top executives in companies which they finance - because this in turn justifies to increase own remuneration to similar levels.
- The whole phenomena gets a proper rational interpretation, as soon as we agree to understand the rather relative character of legal definitions of "property", "ownership" and so on.
- This rather relative meaning of these legal definitions is analyzed and understood in depth in economics and in the science of basic legal forms. The clear separation of these legal forms between owners / property and employees is rather artificial. Normally this artificial view supplies satisfactory results - sometimes not. Here we have a case group where this simplified too primitive view does not supply proper understanding of real world phenomena. Here we have to introduce the occurence of a complex status of "hidden shareholders".
No need to be opposed
- Businesses need persons in the role of owners, in order to develop and to maintain a winning strategy. If nobody is willing to exercise this role properly - not the small investor, not the institutional investor - , then it is a good compromise to delegate a part of this function to business executives.
- It only becomes a political problem if we misinterprete chief executives as employees instead of (in our time) "also temporary hidden shareholders".
- Now we have to verify if the consequences of this new interpretation will supply coherent satisfactory results.
The definition: When does a company executive become also a "hidden shareholder"?
- There are statistics of average salaries and income in bigger companies managed or supervised by personal company owners. The salaries paid in these companies to hired top executives can be considered as "salary" in the proper sense. They are typically much lower than the total remuneration of top executives in companies with more anonymous shareholders.
- Remark: This is an approximation and not a perfect view of the problem. These owner-supervised companies, in order to get experienced and recognized executives, have to compete with companies which pay far more. For this time, we will ignore this aspect and suspend it, waiting for later refinement.
- If top executives get a total compensation of more than 150 % of the average "true salary" level, they can be considered as being also hidden shareholders. The percentage of their "hidden company shares" can be calculated, based on their obtained annual income above 100% of a salary level.
- This annual payment "above a salary level" has to be compared with the profits paid annually to formal share holders, in order to calćulate the "hidden share proportion" of the executives.
- Averaging over several years would be required for more reliability of the calculated proportion.
Now to the details
- We should have some more basic information on the definition level.
- We should find out the consequences: Taxation, responsibility, loss participation, personal liability in case of bankruptcy, profit and loss averaging over several years.
Basic information
"Executive compensation"
- Executive compensation is how top executives of business corporations are paid. This includes a basic salary, bonuses, shares, options and other company benefits.
- There are five basic tools to compensation or remuneration.
- - a base salary
- - short-term incentives, or bonuses
- - long-term incentive plans (LTIP)
- - employee benefits
- - perquisites, or perks
an international problem
- Over the past three decades, executive compensation has risen dramatically beyond the rising levels of an average worker's wage.
- This is valid for most devoped countries - Northern Ameria, Europe, some Asian countries.
- This text is not limited to a specific country. It is formulated in terms which can be understood and applied in all developed countries.
The consequences
No need to regulate some kind of amount restrictions
- This first resulting aspect will be liked by the corporation executives concerned: As soon as the interpretation as "temporary hidden shareholders" is adopted, their remuneration can be tolerated. This would conform with the useful preference for freedom instead of regulation.
- Restrictions would only be required and quite normal if a company benefits from taxpayers money: Not only saved banks but also companies getting quite normal subsidies for major parts of their activity.
Participation in losses
- So far, compensation schemes for executives are a one-way road. This is evidently a main aspect which can not be tolerated. When considering over-average compensation as "hidden company shares", the economic and legal result becomes satisfactory:
- A conventional shareholder has to participate in business problems and in financial losses. This participation is mainly in the form of share ratings dropping below the stock exchange average trend. Let us consider some major stock exchange index as a sufficient measure for this trend. A formula has to be defined how "temporary hidden shareholders" have to participate in some corresponding manner in below average value reductions.
- A special case is if a company undergoes bankruptcy, due to wrong management decisions over the last years. For true shareholders, risk participation is typically limited to their share value. Equal treatment would mean that top executives would have to return compensation amounts of the years since the wrong decisions, as far as this compensation is above the average salary level for such executives.
- It is apparently difficult to define the values to apply. This would result in much addtional business for lawyers and courts... This could mostly be avoided by some clarifying evaluation guidelines in the contracts with top executives.
Taxation: Various case groups would require regulation
- Over-average executive compensation is typically composed from various compensation forms. Tax saving aspects play a major role in this game.
- For all types of over-average compensation, the tax authorities would have to state the redifinition into shareholder profits. This might reduce the taxation level for some payment types. But for all tax saving concepts, the tax invoice would increase significantly.
- Under the point of view of taxation, this additional personal income could be considered as a profit-based income of company owners. Typically, the taxation rules for not reinvested profits would apply.
Unexpected side effect: Exercise of shareholder rights and obligations
- Comparny regulation in all countries typically comprises rights and obligations of shareholders, especially in case of shareholders minorities.
- This will normally not be important for the legal constructs suggested by this text. For example, If top executives exercise their power, they could not in addition claim minority rights.
- But it is required to check in detail if the status of "temporary hidden shareholders" would not result in unexpected consequences. For example, the authorization to make contracts related to shareholders, should be reviewed in detail.
- Penal code aspects should also be reviewed in detail, for example related to corruption or related to the rights of "hidden shareholders" when opposed to the interest of "true" shareholders.
Regulation still required?
Evidently, it will take various years to get clarity by court decisions.
- The suggested interpretation of executive compensation results in reinterpreation, due to some kind of (non-intentional) abuse of legal forms.
- This is never the best solution for a legal system.
- Once that we have stated a phenomena unregulated so far, a better solution would be to accept and tolerate it, and to give it a legal framework. - The essential progress is that we would not any more try to prohibit something by regulation. Instead, we would supply a regulation for the habits as they are.
The required regulation might cover:
- Participation in losses.
- Participation in below-average dropping share ratings.
- Participation also during several years after having left the company concerned (excepted later management errors).
- Submission of all compensation type advantages to standard taxation.
Bonus for invest bankers
This is a very different case....
- Some invest bankers got / get significant bonus payments in order to play risky casino games without compromising the career of the top executives. Who would seriously believe that such activities remained unknown to the top executives of the company... The advantage was / is: If something is going wrong, the jail and image risk is limited to the casino game player. The bonus payments for him move his casino gaming outside the responsibility of the top executives, while they do not refuse to cash the earned huge money amounts in - as long as everything is running well.
- Some invest bankers got / get significant bonus payments in order not to loose the bank customers. If these bankers would leave, the customers served by them would follow them in many cases. It is impossible to maintain a high-level consultants business (also valid for real estate agencies or insurance agencies) without this problem of personal customer binding. It is quite logical that this bonus type typcially increases in time, e.g. over 10 years.
- The interpretation recommendations in this text do not cover these special cases. They would be worth some similar basic redefinition. The result would probably be very different.
Contact + consult
As long as we do not have the regulations, legal battles might deal with this.
- For all questions during such legal battles, and for everything else, you might contact: ok @ fax7.com (or ok @ mrmio.com )
- Please be aware, the first contact has always to define some remuneration. There is no free information supply or answering service.
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