All the previous attention has been on managers’ bonuses and risk incentives. However, there has been a misconception that companies gear the compensation bonuses to manipulate the risk incentive of their managers. In fact, this is not how the plan of managers risk incentives and compensation goes. The traditional practice for generating an optimal compensation portfolio is to engage the plan of managerial incentives with those of its shareholders.
The organization executives confirm the power to execute its board members’ policies, especially the board of directors. Board of directors plays a key role in the company where they represent the interest of the shareholders; the shareholders, therefore, elect them. Although the board of directors holds large share capitals in the company they run, they still have a couple of shortcomings like that “principle agent problem.”
Since there is the occasional occurrence of the mismatch between the interests of the principals and the agents in the company, managers may sometimes control the company shares on their favor against that of the shareholders. They may plan to improve their reputation, influence, increasing their earnings per ratio instead of aligning with their objectives, which is to maximize shareholders’ wealth, and ensuring overall profitability.
Shareholders, therefore, employ some techniques of compensation in order to level the ground that managers had raised on their favor. Shareholders do this by using a compensation plan to put managers in line with the incentives and with the center point shareholders interest’. Thereby increasing the initial value of equity holdings among themselves. This has been to ensure that managers will only benefit by receiving more bonuses when they also increase the propensity of shareholder benefit. Therefore, managers will only be awarded an incentive if they score above the higher-watermark set by the shareholders.
As of now, the structure of the majority of the companies’ compensation plans includes the combination of explicit incentives of both the short term earnings and the long-term performance of the company and also the stability of the company’s profits. For instance, the short-term gain is accelerated by the base salary of managers and the bonus in the system of the recent corporate performance. In contrast, long-term value addition to the firm and the stability are motivated by the company’s restricted types of business examples: options, swaps, floors, futures, and so many.
The corporate body with a well strategic of pay plans ensure managers are provided with incentives to motivate them more and help boost the company’s earnings in the near period. Thy ear also provided partial long-term owner’s equity in the firm through various firm businesses, which later provides them with direct benefit from incentive increments. Manager’s motivation with the level of performance he or she has brought in the company. In an organized managerial compensation package, either incentive with instant payoffs or earnings too far in the future will diminish the value of the managers’ lifetime compensation.