Introduction
Executive compensation has raised the attention of the public as the latest discussion topic in recent years. Prior to the development of modern corporation such compensation had yet to be being developed. In 1896, business organization was began with "New Jersey legislation" (Donahue S.M., 2007, p.63), and later 1901 the first business organization was being developed. At that time the corporation first being developed, they were actually managed by entrepreneurs. In the centered of the 20th century, there are some businessmen evolved to run business organization in American. This group of people did not found companies, but instead were made up from a group of elite top managers who held very significant positions in major organizations.
Although companies are required to disclose their top five executives' compensation, the research of executive compensation generally pays attention on the pay received by the executives and the impacts of lack of disclosure. These executives received the highest pay of anyone in the company, and this pay has increased over time (Donahue S.M., 2007).
The collapses of several well know companies have induced much debate over shareholders' interest are not being taken care off due to ineffective corporate governance structures. Executive compensation is contemn by the public that causing the corporate governance failure (Petra S.T. and Dorata N.T., 2008). Executive compensation packages are recognize as a vital component of corporate governance that design to align the reward of executives and the stakeholders. Therefore, the factors that determine executive compensation is very important, and it has an effect on the company performance (Sapp S.G., 2008).
Agency theory asserts that, the principal and agent relationship is linkage by the incentive pay for the executives, who achieve company goals that are delegated by the principal. To enhance the shareholders' value, a proper incentive has to be designed to align the interest of both parties, that is the shareholders and the executives (Chan. Marjorie, 2008).
Reviewers of executive compensation practices indicate that, the board of directors is dominated by the Chief Executive Officer (CEO), therefore, the board usually does not structure the CEO compensation to maximize the shareholders value. With weaker governance structure tend to have greater agency conflicts, when the firms with greater agency conflicts CEO tends to get more compensation even though the company performance is performing worse (Core, John E. et.al., 1999).
Regulators indicate that, the enforcement on disclosure of executive compensation can improve the corporate governance by allowing the shareholders to reward executives in the manners that are equable with shareholder's value creation. Moreover, disclosure of executive compensation strengthens corporate governance by designing a mechanism that allows shareholder to put some pressure on executives when it is needed (Craighead, Jane A. et.al., 2004).
Main Body
Components, purpose and the need for a well designed/ well planned Executive compensation schemes.
The main objective of executive compensation in being developed was to align managers' interest and to motivate them strive to maximize shareholders' wealth (Chakraborty, Atreya. et.al., 2009). To examine the executive compensation, there are 2 aspects we can look into, which is the amount and the mix of compensation. The mix normally varies along with these measurements: 1) fixed payments, which is non-related with the company performance, versus the risk base payments which is correlated with company performance. 2) "Current compensation accruing at the end of the year, versus deferred compensation accruing in later year" (Veliyath, Rajaram., 1999. p124). Different compensation mix has different impacts on the executive's motivation in the corporate governance views (Veliyath, Rajaram., 1999).
Different components in the compensation mix which differs in having a short term and long term orientation had an effect on executive decision making, especially in differing risk preference among the top management and shareholders. Cash compensation generally focuses on short-term orientation. Salary does not have much impact with company performance, or from one period to another period. Salary is intended to provide managers with subsistence and a little guarantee of financial stability. Whereas annual bonuses based on the company performance for the year, are therefore subject to fluctuation on the bonuses pay out. Equity-based compensations are intended to encourage executives towards long-term company improvement in making corporate decisions and executives are necessitate to work towards the shareholders perspective. In this way, the executive compensation vary between market valuation and long-term shareholders' value, therefore, the variability of this type of compensation affirms a greater of risk sharing and agency costs between executives and shareholder. In order to protect their self interest as they also the owner of the company, they may strive to pursue the desired outcomes that are also the interest of shareholders (Veliyath, Rajaram., 1999. pp.124-125).
Petra, ST. and Dorata, NT., (2008) argued that, the vital compensation objectives of many companies are to hire, reward, motivate and retain the key executives who increases long term shareholders' value. Executive compensation structures therefore comprise the elements created to fulfill the expectations of the executives, while also providing the incentives to satisfy the expectations of the shareholders at the same time. He further claimed that, he found that, executives were being motivated in the form of compensation components rather than the level of compensation to increase shareholders' value. The appearance of performance related pay raises the belief that the manner in which the executives pay is correlated with the company performance for the year. Although this belief may subject to public debate, however, it is certain that pay at risk are often the best and powerful driver of behavior. Swagerman, D. and Terpstra, E. (2007, p.48) stated that, If the executives are not performing well, by providing excessive executive compensation this will decrease the company's value and subsequently, the shareholding of the executive. Theoretically, with performance related pay compensation, this is the best mechanism to align the shareholders' interest and improve the company' value. The well designed compensation arrangement is highly leveraged from the agency point of view.
Executives are often give performance targets to achieve, therefore their compensation packages are often designed to motivate these executives to achieve company performance and work towards the shareholders desired targets. These targets include the goals of the company's share prices that the shareholders would like the management to be achieved. This puts the executives in the unfavourable position of focusing on short term market valuation causing the decisions that focuses on short term objective rather than company long term strategic plan as this will affects the company survival in long term. Furthermore, organization performance related pay incentives should not only be tied with the company's share price. "Indeed, the bursting of the dot-com bubble at the turn of the century is testimony to the dangers of focusing on stock price movement and overlooking companies' operating results. The incentive landscape is littered with the bodies of beleaguered investors who lost their retirement nest egg while the executives of those companies received record-breaking compensation" (Petra, ST. and Dorata, NT., 2008, p.143).
Inherently fraud of executive compensation used in practice that contributed to organization collapses around the world.
Bebchuk, Lucian. and Fried, Jesse. (2004) argued that, since executives manage the company, they are inevitably tempted to maximize their own self-interest rather than shareholders' interest. Especially in the last couple of decades, executive compensation has become the hottest discussion topic in the view of investors. Many observers perceive that executives only concerned their own interest at the cost of shareholders. In this case, executives have used their power to influence over company board of directors to get higher compensation through the arrangements that have little or no relation with performance related pay. It can be concluded that, the executive compensation dilemma is not about the rapid increase of executive pay in recent year, but rather the executive compensation systems have failed to award high pay only for good performance. Duffhues P. and Kabir R., (2007) added, in many practices, strong criticisms were made to those well know companies like Royal Dutch Shell, Heineken, Reed-Elsevier, Unilever and Van der Moolen. These companies are paying high compensation to executives despite their performance in current year were performing poorly.
Another factor is the firm with separation of ownership and control created higher costs for shareholders. Many firms have sought to minimize the agency costs by basing executive compensation on firm performance. Shareholders can adjusts executive compensation by using performance results, such as company turnover and market valuation in order to determine the amount of effort paid by the executives and adjust executive compensation accordingly. Increased on company performance will result in increase their compensation, or vice versa. In this way, shareholders seek to align better executive compensation with their own interests. However, one of the factors that caused the executive compensation inherently fraud is that the executives being compensated with huge amount of compensation that is not tied with the company performance. There are many proven examples such as Global Crossing, WorldCom, Inc., Enron Corp., and others, executives continued to pay large amount money of compensation notwithstanding the failure of the company. This is clearly shown that, the sensitivity of executive compensation and their firm performance is very low (Petra, ST. and Dorata, NT., 2008). For instance, the American International Group (AIG) received funding from the US government "to keep the AIG afloat". There are many well known companies which are laying off their top executives, including one of the US well known bank-Citibank, and yet the AIG top executives are fortunate to keep their jobs and they were also being paid additional bonus payments to retain them at AIG despite the company nearly collapse because of insolvency and no criticism were made to them within the board about the excessive compensation (Postal, Arthur D., et.al., 2008).
Most spectators agreed that by paying high compensation for executives this may compromise their objectivity in managing the company towards shareholder's interest. Generally, the board of directors is responsible to monitor executives and to develop their compensation as well as to protect the shareholder's interest. He further claimed that, in examining existing literature, there were many instances in which it was found that corporate governance problems restrain the effectiveness of the board of directors. In many cases, board of directors had failed to monitor the company management effectively. Executive performance was not being well monitored by the board due to the behaviour of board of director that restrain constructive criticism, and the information asymmetry problems between executives and the board. The problems in board culture can leads to executive compensation. Because directors are less likely to "rock the boat" when they were paid enough, therefore, over-compensation for directors is associated with the culture that does not allow for constructive criticism. For instance, an Enron executive was reported in 2001 to have received the seventh highest executive compensation in the United States, while no criticism was made to them about the excessive pay within the boards (Ivan E, Brick., et.al., 2006., p.404)
Executive compensation determination processes are often influence by the "insider relationship" rather than negotiated at arm's length by the CEO and the board. Because the CEO and the boards of directors often dependent on each other, so they have a close relationship that influence the executive compensation setting at the expense of shareholders. Since the executives would like to have a certainty in their compensation, but shareholders would ideally like to pay their executives at risk, in other words, to pay executives purely based on performance. The proven evidence shows that, executive compensation impacts from different governance factors are sometime mixed. CEO compensation is significant higher and the sensitivity of performance related-pay is lower when the compensation committee contains insider (Sapp, Stephen G., 2008). Bebchuk, Lucian. and Fried, Jesse. (2004) argued that, executives have power to influence over their compensation setting, as a result, they assert, even if the executives are under accountability duty to maximize shareholders' value, executive's compensation contract often failed to provide a proper compensation arrangement that align executives and shareholders' interests. For instance, Tyco International Ltd (Tyco) top management were charged with looting the conglomerate of hundreds of millions of dollars. Top management overstates its company profits and used that profit to pay their executives almost 24 million US dollars in bonuses, but yet, the board's compensation committees are unaware about the excessive compensation packages. This clearly shown that, executives are being compensated with excessive compensation packages when the boards are inefficient and the boards are relative weak (Feingold, Jeff., 2002).
Abuse/ manipulation been the result of disclose flows in the reporting process and the lack of disclosure of company executive compensation schemes.
Continuous debate among the public and regulators regarding the executive compensation structure, design, level that inherently fraud in recent year. Executive compensation disclosure has long been the norm. Primarily, the absence of executive compensation disclosure should be of only minor issues, since shareholders placed trust on boards of directors to monitor the board and the discipline executive compensation. However, the boards of directors actually found their "benefit" is more closely tied to company insiders rather than shareholders. This actually will leads to incomplete and misleading disclosure because the board of directors is only take care of their own interest rather than shareholder's interest (Andjelkovic, Aleksandar. et.al., 2000). Johnson, Shane A. et.al., (2003) asserted that, executives choose to commit corporate frauds is because they found the "benefit" of carry out fraudulent reporting is actually outweigh the "benefit" when they pursue the shareholders' interest. If the chances of being caught and the consequent punishments remain unchanged, an increase in equity-based compensation creates an incentive for executives to disclose fraudulent financial results and mislead the company's share price to the public. He further said that, if the fraud company carrying fraud that has a positive effect on the market value during the fraud period, the fraud company will be underperform compare with the control company.
One of the classic examples was what happened to Enron Corp. What was happen to the Enron cases was the Enron's executives manipulated the corporation accounting disclosure to boost the share price and quickly sell off their share when the share price is at the peak (Llewellyn, Don W.,2004);(Edmans, Alex., 2009). The issue of misleading disclosure is roots from the white-collar activities and tends to happen mainly at the executives, top management. Donoher, William J. et.al., (2007) stated that, they found positive relationship with the executive compensation and the corporate crime. Higher pay for executives tends to have more corporate crime. They observed that, executives who were involved in the corporate scandals were able to ensure their monetary rewards were being secured before the announcement of undesirable financial results. It concluded the positive relationship between the vested equity options and executive's performance is the fundamental of manipulate the reported financial results.
They further asserted that, there are some executives who carried out fraudulent reporting because they wanted to show their organization at the favorable position from the public perceptions and the actions taken are mainly to serve the company. For instance, the reason for management to overstate earnings is to avoiding defaults on liabilities and to boosting the potential investors' perceptions of the company share price before the Initial Public Offering (IPO). The illegal acts can reflect the culture of the company. However, the preponderance of literature that links fraud with benefits actually leads to executives themselves to commit crime, and nor benefiting the company itself. For instance, in this way, which may lead to an increase in executive compensation and benefiting insider through selling off the company stock (Donoher, William J. et.al., 2007). The agency problem persists although there are so many control mechanisms trying to put in place to overcome this problem, this may due to the executives' desires and human beings that are very complexity (Choo, Freddie. and Tan, Kim, 2007). Donoher, William J. et.al., (2007) asserted that, company executives know the weaknesses in the company' internal and external control environment, thus they can manipulate anything they wish to easily. The agency costs arise when the company management's ability to perpetuate asymmetric information. Executives may engage in corporate crime for their own short-term interests and that when agency costs form information asymmetries are high and there is low associated risk for corporate crime, executives may find way to structure their compensation structure in a way that benefiting themselves at the expense of shareholders.
According to Duffhues P. and Kabir R., (2007), the pay for performance sensitivity was very low or nearly non-exist at all. There were strong unfavorable comments made to the total compensation for top management in many well known companies. These companies top management received huge amount of compensation like Ahold and Royal Dutch Shell but the performance of these companies are negative correlated with their compensation. Moreover, many companies are using anti-takeover defenses that resulted in undesirable reputations worldwide with respect to corporate governance quality and there are very limited corporate governance mechanisms to governance about these issues. The root of all criticisms made to these companies has a common problem, which the executive compensation disclosure is very limited. The lack of disclosure of executive compensation can be quite problematic in the sense that the pay for performance is not compromise, because the shareholders have no authority involve in deciding the executive compensation. In this case, shareholders have no control over their agents for setting compensation for themselves, because the management can always manipulate the disclosure, so if executives themselves were compensate too much for themselves, the shareholders' interest may worse off, because shareholders always is the last person who receives the money left in the company.
Conclusion
Executive compensation was first designed with the objectives that align the interest of the company management to strive to maximize the shareholder's interest and it serves as a control mechanism that provide assurance for the shareholders that the executives will always acts in the best interest of shareholders. However, this mechanism has become the threat for the shareholders as the executives now focus on their benefits rather than shareholders' interest, and subsequently the agency costs arise. The shareholders are aware of this since the collapse of Enron, they would like to design the executive compensation structure that pay executives at risk, if they not achieve the shareholders desired outcome, they may be punish by not getting bonus pay. In other words, the shareholders will like to use performance related pay to motivate the executives to work harder. However, although the executives were paying them at risk, but risk averse executives choose to pursue lower risk strategy that dilute shareholders' interest. Furthermore, because of the information asymmetric, executives try to commit corporate crime that only benefiting them. Thus, fraud reporting about the company earnings will be disclosed, so that even though they performing poorly in that year, they still declare huge amount of bonuses for themselves. The government, regulatory bodies, and the company "watch dog" should aware about this issue since this issue has been the subject of public debate for some years ago. There are some rules and regulations that enforce the company to disclose the executive compensation amounts, but the information disclosed is not sufficient enough. The security commission should imposes the rules that enforce every company to disclose their executive compensation structure, levels of pay, and other non-monetary benefits, such as cars, houses, club memberships, must be disclose in the very detail manner. Moreover, the compensation committee must not contain any "insider". The compensation committee normally formed by the independent board of directors, and their benefits to some extent is determine by the executives, so there are conflicts of interest arise between both parties, therefore, the compensation committee may not objectively design the appropriate compensation structure on behalf of shareholders. Thus, the compensation committee must direct report and manage by the majority shareholders, by doing this can eliminate the conflicts of interest. Last but not least, the shareholders must appoint those reputable accounting firms to conduct yearly audit, because by doing this it can mitigate the possibility of fraud reporting, the investors are able to make economic decisions about the company performance. Besides that, investors based on the information disclosed to make economic decisions, it serves as communication tools for the management through the share price movement whether the company is perform in the manner that is also the desires for the investors' point of view.
