Theories and Practices of Executive Compensation

Executive Compensation- Executive Compensation is the pay that is received by an officer of a company. This compensation comprises of salary, bonuses, shares of and call options on the company stock, benefits, perquisites and is configured taking into consideration government regulations, tax laws, the desires of the organization and the executive, and the performance rewards.

Theories and Practices of Executive Compensation- To understand what types of pay systems are most effective and how their effectiveness depends upon the various contingency factors like business strategy, national culture, competitive environment, and employee characteristics a good theory or framework is required. There are some important theories that show how a compensation plan can be used to energize, direct, and control employee behavior.

Reinforcement and Expectancy Theory

Reinforcement theory states that a response followed by a reward is more likely to recur in the future. In compensation management, this implies that a great performance followed by a monetary reward will make better performances in the future more likely. On the other hand, if a great performance is not followed by a monetary reward it is less likely to be repeated in the future. Hence, the reinforcement theory gives emphasis on the importance of a person experiencing a reward. Expectancy theory focuses on the relationship between rewards and behaviors and gives emphasis on expected rewards such as incentives. Motivation depends on two factors: expectancy, which is a link between effort and performance, and valence, which is the expected value of the outcome like rewards. Compensation systems differ according to their impact on these factors. The valence of pay outcomes generally should remain the same under different payment systems. On the other hand, expectancy has more to do with job design and training rather than the pay system.

Equity Theory

Equity theory states that employee perceptions about what they contribute to the organization, what the organization gives them in return, how this return-contribution ratio compares with others in and outside the organization determines how the employees perceive the fairness of their employment relationship. If there is a perception of inequity employees might take action to restore equity. These actions may include quitting the job or non-cooperation. But unfortunately, these actions are in no way helpful to the organization. According to studies, lower-level employees in the organization compare their pay to the higher employees in the organization. If the lower-level employees feel inequitably treated they might take action to achieve equity. So it is imperative that organizations take care that they do not forget the potential adverse motivational consequences of executive pay for the motivation of other employees.

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