Breaking Down the CEO Bonus Structure

In the corporate world, a CEO bonus typically is an incentive-based annual payment to the chief executive officer of a company that is over and above that executive’s salary. The CEO bonus is part of the overall compensation package, which normally includes salary, bonus, stock options, insurance benefits, retirement benefits, vacation, severance and perks, such as a car.

Calculating the Bonus

Part of the hiring process for the chief executive officer of a company includes negotiating how bonuses will be calculated. Typically, this is handled by the compensation committee of the board of directors. A CEO bonus is usually tied to short-term goals that the board and the CEO agree to. These goals can range from specific performance of various aspects of the company’s operation to the general quality of the CEO’s work in the eyes of the board.

Negotiating bonuses is not limited to newly hired executives. The compensation committee will set the bonus structure for an executive promoted to CEO or for a standing CEO. Executive compensation packages are typically reviewed annually by the board.

How Big Are the Bonuses?

Bonuses will vary with every company and every CEO. However, there are some benchmarks. A national study of CEOs at 350 large, publicly traded firms in the United States offers one view. In the study by the Mercer Consulting Group, the median CEO bonus at these large firms was more than $1 million. Compared to the CEO’s salary, the bonus was almost one and a half times larger.

There is a relationship between the size of a company and the relative size of the CEO bonus. The larger the company, the larger the bonus in dollar terms and in relation to salary.

Opinions on Bonuses

It is typical for CEO bonuses to draw more scrutiny from shareholders, the public and the media during an economic downturn. Publicly traded companies release compensation figures for top executives, which gives a general trend for all CEO pay. Even though public opinion typically turns negative on executive bonuses in hard times, most agree that bonuses are a necessary and effective incentive for executive performance.

Benefit to Shareholders

The CEO bonus structure offers two primary benefits to shareholders. First, it is a tangible incentive for the CEO to lead the company to specific goals the board feels are reasonable. In theory, hitting these goals should result in better stock performance and a benefit to investors. Second, the CEO bonus gives a clear measuring stick for shareholders to evaluate CEO performance.

Bonus Considerations

Corporate compensation consultants recommend that investors in a firms be aware of the CEO bonus amount and requirements to earn it. There are several avenues open to shareholders to voice opinions as to CEO performance. These include attending and speaking at annual stockholder meetings, communicating with the firm's investor relations department and communicating directly with the compensation committee of the board of directors. Part of the purpose of the CEO bonus structure is accountability of company management to shareholders.

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