To ensure that executive compensation is working in their favor, investors can take a closer look at how companies are paying their CEOs, according to Investopedia.
Here are five things to consider when assessing CEO compensation programs:
1. Cash/base salaries. CEOs often receive base salaries of over $1 million and will receive cash rewards whether or not the company performs well. When examining compensation programs, investors can check to see how much stake CEOs have in fulfilling their needs by examining whether CEOs' fortunes line up with companies' fortunes.
2. Bonuses. Without bonuses that vary by performance, annual bonuses can often be a base salary "in disguise," according to Investopedia. For example, a CEO with a $1 million salary may receive a $700,000 bonus. If $500,000 of that bonus does not vary with how the CEO performs, the CEO's salary is actually $1.5 million. A company's board of directors can create a balanced set of measures to judge a CEO's effectiveness and continue to give CEOs incentive for high performance.
3. Stock options. Stock options can present problems for shareholders. When shares increase in value, executives can make a significant amount from options, but when shares decrease in value, investors lose money while executives are no worse off. Additionally, the incentive to increase the share price so stock options will remain in the money encourages executives to only focus on the next quarter and ignore shareholders' longer-term interests.
4. Stock ownership. CEOs can connect their interests with shareholders' interests when they own shares rather than options. To ensure this, companies can give executives bonuses on the condition they use it to buy shares.
5. Compensation summaries. Investors prefer it when companies award a larger portion of compensation as a bonus rather than as a base salary, according to Investopedia. Investors can examine Form DEF 14A, filed with the Securities and Exchange Commission, which provides summary tables of compensation for a company's CEO and highest paid executives. The form explains how the bonus is determined and whether the reward is in the form of cash, options or shares.