Academic journal article IUP Journal of Corporate Governance

Motivation and Executive Compensation

Academic journal article IUP Journal of Corporate Governance

Motivation and Executive Compensation

Article excerpt

Introduction

Corporate Governance (CG) has been receiving considerable attention since the publication of the CG report by Sir Adrian Cadbury in the early 1990s. In India, Confederation of Indian Industry (CII) took first step to ensure CG's practices in Indian firms by setting up a National Task Force in April 1997 with Mr. Rahul Bajaj, Former President of CII and Chairman of Bajaj Auto Limited, as the Chairman. The Task Force included members from industry, the legal profession, media and academia. It presented the draft guidelines and code for CG in April 1997 at the National Conference and Annual Session of CII. Subsequently, Securities & Exchange Board of India (SEBI) constituted Kumar Mangalam Birla Committee to promote and raise the standard of CG in India which made certain mandatory and non-mandatory recommendations. These have formed part of Companies (Amendment) Bill 2003, which is yet to be passed. Later, SEBI also constituted Nareshchandra Committee in August 2002 on other aspects of CG and another committee headed by Mr. Narayan Murthy, Chief Mentor, Infosys Technologies Limited to review existing code of CG. SEBI introduced Clause 49 on August 26, 2003 for implementation of these recommendations. SEBI is the watchdog for CG in India which continually debates and introduces various amendments on various aspects of CG.

The two important components of CG in general are:

1. Internal governance mechanism, which consists of:

* Ownership concentration, and

* Board of directors.

2. Executive compensation, which consists of:

* Basic pay,

* Short-term incentives,

* Long-term incentives, and

* Perquisites and benefits.

Both internal governance mechanism and executive compensation are founded on agency theory. Compensation and motivation are inextricably interwoven as weft and warp in the fabric of management. Various theories of motivation and how they impact executive compensation are briefly discussed. This will, hopefully achieve the following two objectives of this paper:

1. To argue that executive compensation has transcended all norms of equitable distribution of surplus earned by the corporation and it has ceased to motivate employees at middle and lower levels.

2. To argue that in view of present evidence, extrinsic rewards, particularly money, is much more important than intrinsic rewards and therefore, compensation should be predominantly in cash based on short-term performance.

Agency Theory

As small entrepreneurial firms grew during the industrial revolution in the 19th century, managerial revolution followed, particularly in the UK and the US. This led to separation of ownership and the control of the firm shifted from entrepreneurs to hired professional managers, while ownership became dispersed among a multitude of unorganized shareholders. Berle and Means (1932) in their classic book, The Modern Management and Private Property, made a fundamental contribution in their analysis of the extent to which management of corporation has separated from its ownership. The authors call it quasi-corporation and without using the exact term they show a keen awareness of the concern of modern agency theory: the interests of the directors and managers can diverge from those of the owners and they often do. This separation phenomenon creates an agency relationship between the owners (shareholders) and the agents (managers). This agency relationship involves agency cost which is the difference between net profits of the firm (had the owners been the managers) and the realized net profit under agents' stewardship. Agency theorists believe that agency costs are unavoidable, however, it is possible to reduce agency costs by using systems to monitor agents' behavior and incentives to align the interests of the principals and those of the agents. Fama (1980) and Fama and Jensen (1983a and 1983b) have suggested a monitoring process of reducing agency costs. …

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