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One of the topmost positions you can secure as a professional working his way up the career ladder is that of a CEO. A CEO’s position while quite challenging is also the most rewarding one. When you hear CEO, you automatically assume that they are handsomely compensated. Making sense of the numbers that companies are paying their top brass, is a little hard. An organization mostly bases an executive’s compensation on well-established policies and good governance that align with the corporation’s overall goals.
Although around 73% of people say that the CEO compensation is too high, the reality is somewhat different. Determining how much a CEO deserves to be compensated can be extremely complicated.
Of course, like regular employees, CEOs’ get an annual salary, but they are also entitled to other rewards and benefits depending on certain parameters like the company growth, performance, shareholder value etc. So, the exact compensation of a CEO is a total package of all the other rewards and benefits, not just the salary.
What is CEO Compensation?
A CEO’s compensation is the total package the CEO earns, including a fixed salary, performance-based bonuses, paid vacations and other benefits. A CEO’s salary is determined by an executive compensation committee assembled by the board of directors of the company.
Why is it important to create a fair CEO compensation package?
It’s important to create a fair compensation package for a CEO in all companies, but especially for publicly traded companies, because they must report how much the CEO earns. Boards have it tough, between offering a good compensation to either retain or attract a new CEO and creating a package that the shareholders are happy with. Getting this right is no easy feat.
What are the components a CEO’s package must include?
To understand how much and how to pay a CEO’s salary you must know the mandatory components the package must include.
There are 5 main components of a CEO’s package. They are-
- Base salary
- Incentives- short term and long term
- Benefits
- Severance pays
- Additional benefits
1. Base salary
Depending on the type of industry, the CEO’s experience and other factors, a CEO’s salary can vary substantially. To decide the base salary of a CEO, the board appoints an executive compensation committee.
Often, CEOs receive a base salary over $1 million. Depending on how well or poorly the company does, a CEO is rewarded. But in general, it’s a given that if the company is paying larger base salaries, the size of incentives decreases, making it harder for executives to stay motivated and make smart decisions.
2. Incentives- Short term and long term
There are two types of incentives a CEO is entitled to, short term and long term.
Short term incentives
To gauge a CEO’s potential, as part of strategic planning, the board of directors set short term goals to achieve. These goals are set based on varied factors, type of business and other conditions. They could be revenue based or operations based like-
- Expansion into new markets
- Development of new products
- Meeting product deadlines
- Increase profits or revenue
Most boards divide the base compensation into two parts, the first is the normal payout made as a salary for expected performance and the second part is a certain extra payout or incentive as you call it made for performance exceeding expectations.
Long term incentives
Long term incentives, just as the name suggests, are rewards given for a CEO’s performance over more than a year, mostly in a three-to-five-year period. In 2021, long terms incentives and payouts accounted for 72% of total CEO pay. long term incentives are usually provided in the form of stock-based compensation by companies. Some forms are-
- Stock options
- Performance vested stock
- Stocks
Long term incentives are usually based on projected future events returns to shareholders, return on assets etc.
3. Benefits
CEO benefits are similar to those of regular employees within the company. Benefits for CEO’s could include
- Medical insurance
- Unemployment insurance
- Paid vacation
- Health insurance
- Life insurance
- Workers’ compensation
- Others
4. Severance pays
A severance pay is something that is provided to CEOs in case of voluntary or involuntary termination. Of course, a CEO’s top priority should be the company and its growth but if there is a merger or an acquisition, it could threaten the CEO’s position, when the new administration takes over. That being said, a severance pay does not just benefit a CEO but also an organization. How?
- In recruiting and retaining talented CEO
- Can interest a potential CEO candidate leaving a long-time employer due to fear of the plan not working out.
For a CEO a severance pay is beneficial when-
- They lose their jobs due to a merger
- Do not have to worry about suddenly put in the dark and losing their source of income
5. Additional benefits or perks
There are some additional benefits only the CEOs are entitled to. And these benefits are provided to them during their need or when they demand for it.
- Special parking space
- Security for executives at home or work
- Private vehicles with driver
- Others
Should a CEO be compensated based on performance?
A CEO is not just responsible for overseeing the entire organization’s operations, but research says that they are also responsible for 40% of company performance. Tying a CEO’s compensation to performance not only is in the best interest of the company but is also the right thing to do.
Conclusion
Determining how much to pay a CEO is a multifaceted decision that requires balancing numerous factors to align the CEO’s compensation with the company’s goals, performance, and industry standards. By carefully considering these factors, companies can establish a CEO compensation plan that attracts and retains the right talent, motivates exceptional performance, and aligns the CEO’s interests with those of the shareholders and the long-term health of the organization.
