Performance-Based Pay and CEO Compensation

Posted: April 13, 2021

CEOs and other executives have been under fire for quite some time as certain parties believe that CEO compensation is disproportionally high. Many justify this belief by comparing the compensation of CEOs to that of the average corporate employee without delving too deeply into the difference in responsibility between the two parties. However, one wonders whether these high salaries might actually be fitting given that the company’s top executive is responsible for successfully leading the organization and improving the lives of their employees. If so, then shouldn’t the CEO’s compensation be tied directly to his/her performance? This article will look at some ways that performance-based compensation plans affect CEO pay. How do CEOs make money? When evaluating executive compensation it is important to look at exactly how CEOs are making their money. This is because, much more so than regular employees, CEOs and other high level managers can make money in a variety of different ways. They can be compensated through traditional salaries, bonuses, stock options, and other structures. The question then becomes which method for paying the CEO yields the best results in terms of executive performance. Salaries, where a CEO receives a set amount regardless of their performance, might inadvertently cause certain executives to do the bare minimum in terms of managerial responsibilities and helping to realize corporate goals. If a CEO's performance is satisfactory or average they will still receive their full salary even if their contributions as the CEO don't add to the value or revenue of their company. In order to get the best results possible from their top executive, most companies will try to align the company’s goals with the CEO’s compensation. This way if the company meets or exceeds its goals then the CEO can expect to get rewarded accordingly. How to motivate CEOs There are a few strategies that boards can implement to motivate CEOs. First, they can require that CEOs become substantial owners of company stock. This means that any decrease in the stock price will directly affect the CEO’s wealth. The board can also tie salaries, bonuses, and stock options to compensation so that they provide big rewards for superior performance and big penalties for poor performance. The board could also institute a threat of dismissal for poor performance, although this might create a rocky relationship between the company and the CEO which is generally something that should be avoided. In 2019, in the United States, just 10 percent of total CEO compensation was made up of base salary and annual incentives accounted for 18 percent. On the other hand, a whopping 72 percent of total CEO pay was made up of long-term incentives and payouts. These sorts of cash incentives are given to the CEO for meeting goals that are usually on a timeline of 3 years or longer. One notable example of a long-term incentive that paid off handsomely for the CEO and the company is Tesla. In 2018, the Tesla board fashioned a 10-year pay plan for founder and CEO Elon Musk that so far stands as the most successful long-term compensation blueprint in history. The structure is highly innovative in rewarding Musk for raising Tesla's market value, and it has delivered brilliantly. Tesla’s stock price is up 979% since 2018, making both Tesla and Elon Musk incredibly rich. This is likely to become the norm for other companies moving forward. Case studies such as that demonstrated with Tesla are just one of the many instruments that Executive Compensation Consultants use to help executives negotiate and secure highly rewarding pay packages. To learn more about maximizing executive compensation, visit our Contact Page, or contact us directly by email at or by phone at 415-618-6060.