Essay Sample: Prime Factors Concerning the Determination of a Firm's and CEO's Remuneration

For the previous year, Oracle boost CEO Larry Ellison's compensation by 24 percent. According to Forbes, Ellison, who ranks sixth in the world's wealthiest men, got a full reimbursement of $96.2 million for the year concluded May 31. Almost all of the reimbursement came in stock options (Oracle boosts compensation of billionaire CEO Larry Ellison, 2012). In the prior year again he got 77.6 million. His reimbursement increased during a time in which the company's shares dropped by 23 percent, floundering the NASDAQ compound Index. The panel's executive reimbursement commission said its longstanding method has involved provision of total reimbursement prospects that are notably above the average of its contemporary group, Cisco and Apple (Oracle boosts compensation of billionaire CEO Larry Ellison, 2012). The approach drew attention to firm's CEO high compensation especially when most employees' wages are medium sized. Below is a discussion of the factors that are included in determining reimbursement for a firm's CEO.

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Firm size

The theory of allocation of constraint depicts that the most gifted executives dominate top ranks in the greatest firms, in a market equilibrium. In these firms, the minimal efficiency of the executives' activities is magnified over the numerous subordinates beneath them, to whom they are linked (Rosen 1992). This theory supports an optimistic relation between CEO reimbursement and magnitude of the firm. According to the studies of Kostiuk (1990) on the impact of the firm size on CEO reimbursement, firm size is undoubtedly a dominant factor in setting the level of compensation for executives (Gabaix, 2008).

Firm performance

The agency theory predicts that there should be a positive correlation between salary of CEO and firm's operation. When analyzing performance of firms, the achievement their internal goals which are determined by; stock price, cash flow, earnings as well as sustainability are considered. An increase in these determinants mean good performance for a company or organization and consequently an increase in CEO compensation (Rosen, 1992)

CEO tenure

The period a CEO holds this executive position in a company profoundly determines his or her compensation level. Logically the longer an individual stays in a managerial position of a particular company the more the pay. The more the tenure means a deeper understanding of the organization, more experience, and various network connections. Also, CEOs exert more and more influence on the Board of Directors as their tenure increases. This substantial influence might stem from the fact that managers nominate new board members for their future benefit, (Hill, 1991).

Reasons that best elaborate reduction of remuneration for top executives in recent years The six-fold expansion in CEO remuneration between 1980 and 2003 can be accredited to the six-fold rise in the capitalization of markets in larger U.S. firms in that duration, (Gabaix, 2008). Over this period the executive pay had risen dramatically especially in the western economy. The increase brought about a lot of debate on the acceptability of the executive pay levels to society, transparency and effectiveness of remuneration committees and whether shareholders needs were being met. This lead to some restructuring that has contributed to remuneration decrease for top managers in past years.

Value for your money

The incentive pay system required executives to be paid for their performances. The system is like an investment. The rapid increase in CEO compensation while poor performance in companies prevailed led companies to reevaluate and be clear about getting their money's worth. Performance pay is now deployed with cold analysis, unlike the blind faith that was placed on Star CEOs (Rosen, 1992).

Short, simple and relevant

Organizations are putting in new and simpler paying systems, unlike the complex ones that drained employees' motivation. The previous system of costly performance-based incentive with added financial regulators was complicated. Relevance is considered as more straightforward plans that take into account both executives and shareholders by considering stock holding periods are being used (Gabaix, 2008).

One size does not fit all

Also, reduction of compensations for top managers have reduced in past few years because companies have taken into account different demographic groups and paid them accordingly. The centralized incentive-based payment system is costly and does not work effectively. Different CEO's experience different levels of risk and geography thus different pay (Hill, 1991).

References

Gabaix, X. &. (2008). Why has CEO pay increased so much? The Quarterly Journal of Economics.

Hill, C. W. (1991). CEO tenure as a determinant of CEO pay. Academy of Management Journal.

Oracle boosts compensation of billionaire CEO Larry Ellison. (2012, September). Retrieved September 2012, from Mercury News: http://www.mercurynews.com/business/ci 21608643/oracle-boostscompensation-billionaire-ceo-larry-ellison

Rosen, S. (1992). Contracts and the market for executives.