Compensating Executives Based on Performance

Abstract

The question of fair executive compensation could be resolved if we develop a framework and measures to determine whether executives are compensated fairly by firms. Executive compensation is a business decision, and it should be based on business performance. This paper presents tools for investors and analysts for analyzing executive compensation, and provides for the board of directors a framework for developing a fair executive compensation policy. The model for executive compensation includes four variables: culture, governance, disclosure, and oversight, for creating an environment for the board of directors to evaluate and formulate a fair compensation policy. The model includes two measures: (1) an executive compensation ratio—a measure for comparing executive compensation to the value created for the firm during a period of time and (2) a comparative compensation ratio—a measure for comparing executive compensation with employee compensation. The researcher recommends that the management share these measures with the public in both quarterly and annual reports.