Why Corporate Boards of Directors link top Managers’ Compensation to Corporations’ Stock Prices

Since corporate value is tied to stock price, corporate boards of directors usually link executive compensation to that price. Making stock options a significant part of executive compensation became their preferred approach of aligning managers’ interests with those of shareholders (Kotnik et al. 2018). Chief executive officers (CEOs) and other high-ranking executives had built up sizable equity and option positions by the mid-1990s. CEO pay rose in tandem with the stock market. This does not mean, however, that a company’s performance is linked to its CEO’s pay, because even when the market is booming, stock options reward both excellent and poor performance equally.

For incentive compensation to work, corporate boards must adopt the appropriate measures and performance levels, as shown by Kotnik et al. (2018). Executives who are held accountable for the entire company should, in principle, be compensated with stock options as a performance incentive. The share price, after all, determines the value of a stock option because it contributes so heavily to overall shareholder returns. Despite some managers’ claims to the contrary, the evidence does not support their position. Shareholders expect boards to reward management for outperforming the company’s peers or broad market indices in terms of returns. Using this metric, institutional investors can tell which companies are doing well and which are not.

The Securities and Exchange Commission requires companies to publish in their annual executive compensation statement the total return to shareholders relative to their peers or the market as a whole to aid investors in monitoring executive salary. In spite of the fact that many boards of directors and CEOs publicly stress the importance of increasing shareholder returns, current stock option systems reward both average and exceptional performance alike (Kotnik et al. 2018). Thus, corporate boards of directors may link the compensation of senior executives to the stock price of the company in order to improve the performance of the company in the stock market hence making stakeholders and investors happy.

When a company commits fraud, it is acting unethically or dishonestly in some way (Goldberg et al. 2016). Most of the time, corporate fraud is committed to benefit a certain person or business. These schemes go beyond the specified responsibilities of an employee and are notable for their complexity and financial impact on the firm, other employees and third parties. Employer compensation that follows stock price fluctuations can lead to three types of corporate fraud, all of which benefit the company’s executives. The pay of business CEOs often depends on the financial performance of their companies. Consequently, they have a direct interest in portraying the financial situation of the company in a positive light in order to exceed previously set performance goals and increase their own pay scales. Second, it is a very straightforward process. The Financial Accounting Rules Board (FASB), which establishes GAAP standards, allows for wide interpretation of accounting provisions and methodologies. For better or worse, GAAP standards provide management a lot of latitude in presenting the company’s financial health. The third reason is that the intimate relationship between the independent auditor and the business client will obscure financial manipulation. In corporate auditing, the major firms of accounting are joined by a slew of smaller regional firms. According to Nigam et al. (2018), these companies are paid by the very companies they audit, despite representing themselves as independent auditors. This may cause auditors to depart from accounting laws in order to depict the company’s financial health in a favorable light to the client (Goldberg et al. 2016).

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