How Do CEOs Pay Themselves

How Do CEOs Pay Themselves

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Cash/Basic Salaries
These days, CEOs often receive base salaries well over $1 million. In other words, the CEO gets a terrific reward when the company does well. But they still receive the reward when the company does badly. On their own, big base salaries offer little incentive for executives to work harder and make smart decisions.

Be careful about bonuses. In many cases, an annual bonus is nothing more than a base salary in disguise. A CEO with a $1 million salary may also receive a $700,000 bonus. If any of that bonus, say $500,000, does not vary with performance, then the CEO's salary is really $1.5 million.

Bonuses that vary with performance are another matter. CEOs who know they'll be rewarded for performance do tend to perform at a higher level because they have an incentive to work hard.

Performance can be gauged by any number of things, such as profit or revenue growth, return on equity or share price appreciation. But using simple measures to determine appropriate pay for performance can be tricky. Financial metrics and annual share price gains are not always a fair measure of how well an executive is doing his or her job.

Executives can get unfairly penalized for one-time events and tough choices that might hurt performance short term or cause negative reactions from the market. It's up to the board of directors to create a balanced set of measures for judging the CEO's effectiveness. (See also: Evaluating a Company's Management.)

Stock Options
Companies trumpet stock options as one way to link executives' financial interests with shareholders' interests.

But options can also have flaws as compensation. In fact, with options, risk can get badly skewed. When shares go up in value, executives can make a fortune from options. But when they fall, investors lose out while executives are no worse off. Indeed, some companies let executives swap old option shares for new, lower-priced shares when the company's shares fall in value.

Worse still, the incentive to keep the share price motoring upward so that options will stay in the money encourages executives to focus exclusively on the next quarter and ignore shareholders' longer-term interests. Options can even prompt top managers to manipulate the numbers to make sure the short-term targets are met. That hardly reinforces the link between CEOs and shareholders.

Stock Ownership 
Academic studies say that common stock ownership is the most important performance driver. CEOs can truly have their interests tied with shareholders when they own shares, not options. Ideally, that involves giving executives bonuses on the condition they use the money to buy shares. Let's face it: Top executives act more like owners when they have a stake in the business. 

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