Measuring Fair Compensation in the Realm of Corporate Governance

Posted: April 30, 2020

In the realm of corporate governance, what defines fair compensation is largely subject to interpretation and involves a complex array of factors. The expectations for executive pay vary across industries and involve a spectrum of modes of compensation in addition to a base salary. Across nations, compensation for corporate executives varies based on local tax laws and regulations. Setting compensation for the CEO is a primary responsibility of the Board of directors of a public company. What is fair? Obviously the compensation must be high enough to attract and retain the candidate the board believes to be the right person to lead the company—based on experience, skills, and leadership track record. Next, the level of compensation must be competitive relative to the pay of CEOs among competitor companies and similarly situated companies. Typically a compensation package has many components. Some are fixed like annual salary, others like an annual bonus are typically expressed as maximums to be earned by meeting performance goals and yet others are option grants or restricted stock grants that vest over the long term—and are designed to keep the CEO at the company for five to ten years to be fully earned. Of course, the Board has a fundamental duty to specify the performance metrics that the CEO and his management team must meet to achieve their compensation. These metrics will vary depending on each firm’s goals and philosophy for maintaining effective and optimal corporate governance. Usually some combination of growth in revenues and profits, stock performance, and ensuring diversity are featured. A hallmark of effective corporate governance is how well the CEO is executing the five-year strategic plan which typically details product and geographic expansion along with financial performance. Another component of corporate governance is the level of shareholder engagement. According to the Harvard Law School Forum on Corporate Governance, the responsibilities and compensation of corporate executives are largely subject to the voice of shareholders and activists about how capital should be allocated in the long term and short term. Corporate governance and compensation vary when successful founders stay on as CEOs. Warren Buffett has drawn only a straightforward salary of $100,000 annually with no bonuses and no stock option grants in history. Of course, he owns a significant share of Berkshire Hathaway stock—and his mantra is that his interests as owner are fully aligned with public shareholders. Amazon’s Jeff Bezos has never received a stock option grant since Amazon went public and his compensation remains unchanged over the past decade. Zuckerberg of Facebook has followed a similar model. On the other hand, executive compensation for many companies has drawn criticism from the public eye for driving income disparities. A 2003 Harvard study revealed that the compensation paid to the top five executives in a company “accounted for about 10% of that firm's earnings in 2003, compared to 5% in 1995.” While high executive pay can ensure adequate talent is attracted and retained, high executive salaries are liable to exacerbate the wealth divide in the United States. If the activity of CEOs and executives are not checked, it can often result in long-term goals being sacrificed for short-term gains vis-a-vis reckless financial decisions made by these executives. This is why Board oversight is key in the domain of corporate governance. Ultimately, for compensation to be deemed “fair”, the Board needs to ensure that during difficult times such as the current pandemic when there are layoffs, they can prevail upon the CEO to take a 20% pay cut and to forgo any bonuses until business gets back to “normal.” Corporate governance calls for routine oversight and navigation of the implementation of policies regarding compensation in order to create value in the long term and ensure that the vision of the organization is effectively maintained and propagated. To learn more about measuring fair executive compensation, visit our Contact Page, or contact us directly by email at or by phone at 415-618-6060.