1 INTRODUCTION
The executive compensation is frequently cited as a chief candidate for the financial crisis(Bruce,
Skovoroda, Fattorusso, & Buck, 2007). Though academic evidence of such claim is surprisingly sparse,
this paper looks to justify the claim, cite potential problems with respect to financial accounting and
reporting.
2 JUSTIFICATION OF PERFORMANCE BONUS TO EXECUTIVES
There is a philosophy that executive performance and compensation should be aligned so that paying
more to the executives is motivational and yield better performance (Ederhof, 2010). Rajan &
Reichelstein (2009) had said that senior executives are responsible for making sound investment and are
capable of making better financing decision securing the interest of investor and shareholder. The
theory, which is based on human capital, concerning executive compensation, relates the size of the
company as a yardstick to measure how tough is the executive job (Caylor & Lopez, 2013). Since the size
of the company and executive’s compensation are closely related to each other, the complexity of the
job is equally important to determine the pay. Most of the corporation argues that if they do not provide
enough performance packages to their top executives, they may suffer executive turnover thereby losing
a promising executive of the organization. Some also argue that rise in private equity and global war of
talent push the case for high executive pay.
3 PROBLEM DUE TO PERFORMANCE BONUS
Performance based pay to the top executives and senior manager can pose serious outcomes who
implement it. Stock option and large bonuses have been held responsible following the global crisis of
2008 for short term strategies and risky behaviour. The role of senior managers and executive director is
to perform a creative task while other employees perform a routine task. Variable pay like performance
bonus substantially increases the performance of people doing a routine task, while it hurt the
performance of people who are involved in a creative task where the non-standard and innovative
solution is needed (Ariely, Duke, & Economics, 2010).
For example, net income of a company measured the success of any company shown in financial
statement. But, it is not always the case. When company cannot able to collect its receivables, profit is
meaningless. The worst case scenarios arise when company borrow money to pay performance bonus.
Cash should be available if company was truly making profit. The problem of overpayment can be seen
on one instance when CEO of Dean Foods was given 52% performance bonus from the previous year
even though company suffered the loss of $1.6 billion in the same year (Graffin, Boivie, & Carpenter,
2013). Morgan Stanley, a global financial service company who provide financial services across the
world, reported to set aside $7billion for performance bonus to its senior employee in 2015 although the
company suffered quarterly loss in the given year(Cheng, Harford, & Zhang, 2015). These outrageous
practices lead the company to an economic and financial loss affecting long term goal of the company.
4 CONCLUSION
Executive performance bonus has been the significant component of corporate governance. It is often
governed by investors, the board of directors, compensation committee member and shareholders.
Performance bonuses should not form the part of the remuneration of top manager because the nature
of their work doesn’t match the performance based pay. The task of the senior manager and executive is
to perform a creative task and this job type is completely unsuited to substantial variable pay. As
performance pay demand some metric to be used to measure the performance of the person, whatever
is the performance criteria it is simply impossible to succinctly measure someone performance.
As an alternative, the company should agree to a fixed income for its senior manager and executives
that should be correlated with their performance and if they consistently perform well they should get
high income. The company should set clear cut policy that performance bonus should be given only
when the company is in profit. The board of director can require that top executive become the owner of
company stock. Performance bonus, salaries and the stock option should be structured in such a way
that rewards should be given for superior performance while penalties for poor performance and threat
of dismissal should be made real for poor performance.
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