Determinants of executive salary in a competitive market.

AuthorJha, Jatinder Kumar


The cost associated with losing employees and recruitment, selection and training new employees often exceeds 100 % of the annual compensation for the position (Cascio, 2006). Therefore it is very important to retain the key employees because of not only the financial loss but also the tacit or strategic knowledge loss that goes with the leaving employee. Work disruptions, loss of productivity, customer service and diversity are a few other consequences of resignation of an employee (Aleen, Bryant & Vardaman, 2010). Pay dissatisfaction is the major reason for job quitting. Compensation and benefits are great motivators so organizations need to focus on this strategic area for acquisition and retention of key employees. Pay is a strategic decision of the firm since acquisition and retention of the key employees depends up on the pay structure. Research has shown that market survey reflects the external worth of jobs and job evaluation reflects its internal worth (Remick, 1981). Pay satisfaction is the positive or negative feeling of the employee for his her pay (Miceli& Lane, 1991). There are number of factors that influence the pay satisfaction. Perceived pay fairness is one of the determinants of pay satisfaction (Berkowitz et al., 1987; Dyer, Schwab & Theriault, 1976; Folger & Knonovsky, 1989). Fisher and Govindarajan (1992) found positive relationship between age, tenure, experience and years of education of profit centre managers with compensation. They further found that profit centre manager gets higher compensation with increase in its size. Rouzies et al. (2009) found that variable to fixed pay ratio of sales professional depends up on tax regime (tax burden on employee & employer) and complexity of task. Challenging job is difficult to evaluate; so fixed component dominates the variable part. After extensive review of the existing literature on wage determination we came up with a conceptual framework that explains how labor immobility influences the wage rate in competitive labor market. We have further explored the factors contributing to labor rigidity including union membership, institutional factors, inflow of migrant workers and skill level. We have drawn our argument on Segmented Labor Markets (SLM) Theory that emphasized on the existence of dual labor market (primary and secondary sectors) with some institutional barriers that prohibits the labor mobility across the segmented markets (Dicken & Lang, 1985; Doeringer & Piore, 1971). We have studied the impact of social networks on the compensation level of managers and CEOs. While studying the determinants of wages our major focus was on exploring the factors influencing the labor mobility across the industries. We have discussed the determinants (fig. 1) of executive salary/CEO salary and have synthesized the existing literature under relevant subheadings (factors). We then explore the literature on determinants of wages and proposed the conceptual framework (fig. 3).

Employee compensation means all types of pay given to the employees under their employment contract. Direct financial payment includes wages, salaries, incentives, commission and bonuses. On the other hand indirect financial payments comprised employer paid insurance, leave travel concession etc. Various legislations like Minimum Wages Act, 1948, Payment of Wages Act, 1936, and Equal Remuneration Act, 1976 etc. influence the structure, computation, and payment of wages. Pay Commissions in India give their recommendation to fix the salaries of government employees. Government forms wage boards to decide the salaries of various occupational groups. In India, apart from compensation legislations, unions also influence the pay plans through formal collective bargaining with the employers (Dessler & Varkkey, 2011).

Determinants of Executive (CEO) Salaries

Acquisition and retention of key employees is a very challenging job. In today's competitive job market talent management is really a big challenge for any organization. There are a lot of choices available for the job seekers. In order to attract the talented pool of employees, organizations are designing their compensation plans in such a way that would lure the potential candidates for joining their organizations. Compensation determines the employee attitude, motivation and behavior in the organization (Gerhart & Milkovich, 1992).

Human Capital

Human capital includes age, experience, tenure, and skills of an employee. Logic for positive relationship is that the managers who invested in acquiring job relevant skills should get the premium. Hambrick (1989) found that functional expertise/background and prior experience affect the compensation.

Firm Size

Research has found a relationship between firm's size and executive pay (Rich & Larson, 1984). Job complexity refers to the magnitude of responsibility vested in the job. Gomez-Mejia et al. (1987) found that in management controlled organizations firm size predicts the total compensation, bonuses and base salary of executives. The relative size of profit centre (size of profit centre/size of firm) is positively related to the salary and bonuses of the profit centre manager. As size of the firm increased complexity increases therefore executive with greater expertise is required (Becker, 1964). Fisher and Govindarajan (1992) in their study found that profit centre manager gets higher compensation with increase in profit centre size.

Managerial Discretions

Performance based pay (bonuses, stock options) would be effective if managerial discretion is high since high managerial discretion means many options available for decision making (few constraints), behavior and decisions are difficult to predetermine, impact of their decisions are unobservable or ambiguous and firm's performance is volatile. These discretions are stemming from a complex/ diverse business strategy and uncertain (dynamic) environment (Rajagopalan & Finkelstein, 1992; Hambrick & Finkelstein, 1987). Finkelstein and Hambrick (1989) found managerial discretion increases with firm diversification. Magnan and Stonge (1997) found that high managerial discretion (whole sale customer, foreign, international business etc.) in banking industry leads to performance based compensation.

Diversity in Board

Power of the CEO influences the compensation positively by ignoring economic factors (firm specific factors, job etc.) (Brick, Palmon & Wald, 2006). Power of CEO is coming from his tenure (Shen, 2003), expertise and prestige (Finkelstein, 1992), equity ownership (Cannella & Shen, 2001) and chairmanship (Westphal & Zajac, 1995). Directors are representatives of shareholders and they have fiduciary duty to protect the interest of shareholders but powerful CEO appoints passive directors (Zajac &amp...

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