Executive Compensation Plan
Executive compensation plan is referred to the contract between a company and its management executives that aims to encourage and motivate the executives for the achievement of the company’s visions and objectives (Hassen, 2014). The existence of executive compensation plan arises from the conflict of interests between principal and agent. Principal who is aka as shareholders do not involve in the daily management of company; whereas, they employ the agent to act on their behalf on the management. However, agency costs are always incurred due to information asymmetry and the potential divergent behaviors of management executives; particularly of their self-interests. Thus, the implementation of compensation plan is necessary to minimize the agency problems, and advocate the alignment of their goals with the company’s in overall (Deegan, 2011).
Components of Executive Compensation Plan
According to Deloitte (2015), it is commonly effective to provide a compensation plan consisting of a mixed of both cash and equity incentives. Cash incentive includes the annual base salary, annual bonus plan, and executive benefits plan; meanwhile, equity incentive is a long term incentives plan that based on the share performance. The ratio of cash to equity incentive is estimated of 6:4 from which base salary occupies for 30%, followed by bonus plan at 20%, 10% for benefit plan, and the remaining portion is of equity incentive. Each component will be briefly discussed with its allocation, and the possible drawbacks from each component will be reasonably justified in accordance to Positive Accounting Theory (PAT); mentioning that opportunistic behaviors of management executives are often driven by the compensation plan offered to them (Sun, 2012).
Annual Base Salary
It is recommended to provide management executives base salaries that are at least equal to the marketplace. The consistency of base salary with the market value is crucial to retain key executives from switching to other workplaces that offer better or higher pays. Besides, the base salary should be entitled with increment over certain period; especially when executives are expected to assume more expanded roles and responsibilities. Alignment of workloads with equivalent salary payout is critical to maintain the motivation and willingness of executives for continually working in the same workplace (Solomon, 2015).
Annual Bonus Plan
Annual bonus plan is a great rewarding push to management executives from which it is implemented based on a set of performance metrics. Executives will be rewarded if they achieved certain pre-determined targets resulting from the financial and operational performances (Ederhof, 2010). For instance, executives will be given an additional of one month’s salary as bonus if the operating income is increased by 10%. Nevertheless, Arora & Alam (1999) stated that performance-based pay will high likely lead to manipulation of accounting figures. This is possible as executives may produce ‘creative accounting’ with the intention of achieving the performance target, and acquiring the rewarding bonus.
Executive Benefits Plan
Executive benefit plan refers to a wide coverage of benefits offered to executive; including private retirement benefit, working-related incentives, family initiative, health insurance plan and etc. (Meyerowitz, 2013). In fact, offering benefit plan to the executives is a practical appreciation for their services that in turn is useful to motivate the executives’ performances. Moreover, the retention rates of executives would be higher by providing benefit plan because some benefits such as vehicle and property ownerships are only available to executives upon their retirements. This kind of compensation plan is more pragmatic to prevent any accounting manipulation or other opportunistic behaviors.