Concerns about economic equality have risen in recent years and have even erupted into protests such as the Occupy Wall Street movement in 2011. A significant portion of the outrage was centered on topics such as Executive Compensation and it’s disparity to the average workers wage. Critics of the executive compensation structure wonder how well the current system of paying executives is working and if it could be improved. Many questions are raised as to how much compensation was adequate and the corresponding effects on the organization. The Board of Directors of many organizations is under direct scrutiny for their role in determining executive compensation policies. In theory, through the electoral process of public companies, shareholder interests should perfectly align with management, although this is not always the case. Shareholders elect the Board of Directors, who in turn, acting as agents of the shareholders, elects the officers. A compensation committee is formed to develop compensation packages that encourage officers to reach the goals and expectations of the shareholders. However, executive compensation policies are often quite complex and this electoral process can fail to meet its objective. By the 1980’s, these packages were weighted heavily by incentives including company stock, stock options, and cash. Due to complexity and lack of experience, some compensation committees may have been unprepared to make informed decisions about executive pay (Smith). Compensation committees must have a diverse skillset as well as include a financial expert with an extensive knowledge in human resources. These committees should have an understanding of best practices and effective strategies, as well as how the compensation structure compares to others in the industry. This committee is charged with the duty of determining if the pay program is conducive to the organizations long-term business objectives and their performance and talent requirements. Determining if the pay program encourages the appropriate level of risk-taking to meet the expected return on capital of the shareholders is also another decision that the compensation committee is responsible for. Several relationships can be evaluated to determine the effectiveness of a compensation policy. A relative pay comparison will confirm that executive pay is in line will historical norms and with other firms in the industry. Sharing ratios measure the proportion of value created from top executives and if they receive too much, or too little, of the company’s and shareholder’s incremental value creation (Edmans). A simple spreadsheet can also be utilized listing the components of compensation in comparison to other years to illustrate significant changes and the effect on realizing the organization’s goals. Compensation committees need to remain vigilant in order to best serve their organizations and their shareholders. Rigorous processes should be in place to monitor the executive compensation on an ongoing basis. Executive compensation is defined as ”the financial payments and non-monetary benefits provided to high level management in exchange for their work on behalf of the organization.” Compensation packages usually consist of a base salary, short-term incentives, long-term incentives, benefits, perquisites, and insurance (Diamond). Most organizations can use these six components in an equation that can be tailored to the needs of the organization and to address the needs of shareholders. This equation can be skewed to promote performance by upper management or to encourage risk aversion. The compensation package for executives at a growth company may be drastically different than those of an organization in the Utilities sector. Severance packages are also a component often used in executive compensation. These agreements specify that an employee will receive benefits in the event they are terminated. Excessive severance packages, named Golden Parachutes, are a controversial issue that receives frequent media attention. Golden Parachutes are usually a combination of severance pay, cash bonuses, stock options, and other benefits. Supporters of Golden Parachutes argue that they make it easier to attract and retain talent and help the executive stay objective during the takeover process. Golden Parachutes also increase the cost of, and deter, takeovers. Critics will argue that executives are already well compensated and that Golden Parachutes create perverse incentives. Most compensation programs are developed around the motivation model, the assumption that executives work more effectively if rewards are tied to results (Lorsch). This model is flawed in many ways. Often executives have very little control over their results and the fact that results are more likely the result of the contribution from the entire organization and rarely from one, or a few, individuals. The stock price, the base for judging performance, typically follows the general market, regardless of the effectiveness of corporate executives. This raises the question, is executive compensation a driver of performance, or simply a consequence of rising equity values? Corporate Governance is an underlying theme when arguing for executive compensation reform. Corporate Governance is a mechanism for aligning executive-shareholder interests, incentives, an encouraging accountability (Lorsch). When this mechanism is operating effectively, it allows the organization to attract and retain quality talent with a moral compass. Numerous inferences can be drawn upon an organization’s Corporate Governance by simply examining their executive compensation structure. If an executive is paid a relatively small salary in relation to his or her total compensation, it implies that the goals of the organization are heavily weighted toward performance. Accountants, specifically auditors, study the compensation policy of executives to determine the “Tone at the top”, which is a term used to describe an organization’s ethical climate. When compensation is strictly tied to performance, auditors assess risk higher due to the incentive to commit fraud in attempting to achieve or enhance financial results. Several issues evolve as we closely examine executive compensation plans, most notably the role of agency theory. As an agent, upper management is supposed to act in the best interests of the principle, the shareholders, rather than his/her own interests. However, difficulties emerge surrounding moral hazard, a situation where upper management will take risks because they may realize rewards while the potential costs will be absorbed by others. The purpose of executive compensation is to directly align upper management’s interest with those of the shareholders, but this link can be severed due to conflicts of interest. Short –termism is another significant problem in developing the right executive compensation policy (Lorsch). Executives need to be rewarded for their efforts in providing long-term business performance as well as in the short-term. Recently, many policies have been overly encouraging, intentionally or not, performance in the short term. We currently see packages moving farther away from fixed salaries in favor of stock options and differed stock (Smith). The trend toward these types of incentives has caused executives to concentrate on increasing short term stock prices. This, of course, is typically not in the general investor’s best interests. As equity compensation increases, we often see consequences such as “information overload,” were companies are releasing so much information, which is often unreliable, to try and increase a firms stock price. This increase in information makes it more difficult for investors to make reliable decisions. While there are numerous critics of the current state of executive compensation, there are some who argue its necessity. Much of the increase in executive pay over recent years can be explained by the global war for talent. It is not uncommon for top executives to transfer to a direct competitor. Often upper management will switch to the private sector where he/she can receive a higher total compensation because private companies do not have to report executive pay to shareholders like public companies who file reports with the Securities and Exchange Commission. Most employee’s compensation comes from a salary, while a large portion of executive pay comes from incentives. However, the link between executive compensation and performance is unclear (Diamond). By strengthening the independence of directors and compensation committees and increasing shareholder rights in electing the directors, this link can be mended. Properly structured compensation packages should give executives strong incentives to think about the success of their organization in the long term and to avoid taking risks that are out of line with shareholder interests. One simple way to encourage executives to dial in risk is to compensate them with company debt obligations along with their equity compensation (Edmans). Issuing debt and equity compensation will align management’s interest with both debtors and creditors. Some firms are also lengthening the time it takes for executives to cash in on their stock options. This practice deters management from making decisions for the sole purpose of pumping up the stock price in the short term. Rebalancing an executive’s compensation, similar to that of a securities portfolio, will assure that compensation is not concentrated too heavily into stock options to keep interests aligned as initially planned (Edmans). Building a corporate culture centered on responsibility and accountability has become necessary to address the shortcomings of executive compensation. Shareholders want greater transparency and independent checks to make sure minimum requirements are being met. Organizations must include a system which identifies potential conflicts of interests as part of their overall executive compensation policy.