Definition of executive compensation

It is the role of the chief executive (CEO) and other executives to oversee the company’s strategy and operations.  Obviously, these individuals require compensation for their work.  It is the responsibility of the compensation (or remuneration) committee of the board of directors to design executive compensation contracts.  The “right” amount to pay an executive is the minimum amount it takes to attract and retain a qualified individual.

In addition, the compensation package should be designed so that it motivates the executive to perform in accordance with the company’s objectives and risk tolerance.   Executive compensation packages generally include a mix of short-term incentives (including salary, annual bonus, benefits, and perquisites) and long-term incentives (including stock options and restricted shares).  The package may also include guarantees such as a severance agreement, change in control provision (if the company is bought out), and pension.

Example
In 2009, James Skinner, CEO of McDonald’s, received total compensation of $17.6 million.  This included salary of $1.4 million, an annual bonus of $3.3 million, a long-term cash award of $8.3 million, stock awards of $1.7 million, stock options of $2.2 million, and benefits and perquisites of $0.7 million.  Skinner’s employment contract also included a change-in-control provision under which he would receive three times his base salary and bonus if McDonalds was sold to another company.  The change-in-control provision was valued at $19.9 million in 2009.  Executive compensation levels have been criticised in recent years, giving rise to shareholder activism.  [1]

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