Compensation Contracts: Everything You Need to Know
2. Executive Pay
Updated November 19, 2020:
Employers use compensation contracts to record a negotiated change when it comes to earnings and wages for employees. For instance, a new employee who completed a probationary period can negotiate with an employer regarding the new amount of wages they will receive, and both parties need the compensation agreement to record the change in compensation.
A compensation contract is a supplemental document to an employment contract in the sense that it does not replace it but changes certain details about employee compensation based on new circumstances. A good example is LawDepot’s compensation agreement, which allows you to enter vital information about earnings, and you may add more clauses based on your circumstance.
Further, written employment and compensation contracts are usually the exceptions. In certain cases, such as hiring high-level employees, it makes more sense to mandate an employee to sign an agreement.
A compensation contract is also known as:
- Salary agreement
- Employee compensation agreement
A compensation agreement must include information pertaining to all parties involved in the negotiation process (ex. the employer and employee), including compensation details on how the employee will be rewarded for the work involved. For instance, negotiations must pertain to hourly wages, commission, or annual salary.
The contract needs to mention such matters as receiving wages in the form of bi-weekly or monthly intervals. For instance, a salesperson could be entitled to get a bonus if they surpass sales goals during a particular quarter. An employment agreement usually covers the following:
- Employment terms or the period in which employees will work for the business
- Details regarding holidays
- Sick leave
- Bereavement policies, including information on initial compensation an employee, is owed when they first begin employment
A compensation contract usually covers various topics at some time during the employment term discussions:
- After an employee completes a probationary period or finishes an annual review to create any changes in the wage structure.
- Raises or bonuses
- Amendments to non-monetary compensation forms, such as personal or vacation days
The agreement itself records an employee’s new wages and other new details pertaining to compensation.
In a new study, the research assessed whether executive compensation agreement is designed to maximize a firm’s value. Overall, the debate rages over executive compensation contracts in the academic and public arenas. Supporters of “value maximization” note that executive compensation agreements are designed to attract the best candidates and provide special incentives for executives in a competitive market, primarily to enhance shareholder value.
On the other hand, supporters of rent extraction theories stress that market forces will not work in such a setting because executives can set their own compensation standards, allowing executives to extract rents to the detriment of shareholders. Such a debate is most prominent in economics, finance, and law. Further, the debate has vital policy implications regarding the limitations of executive compensation.
Regardless of the importance of the debate, the question of whether executive compensation maximizes firm value has yet to be answered because various challenges still exist in assesses the causality within this area. Directors, consultants, and executives spend a great deal of effort and time in crafting compensation agreements, considering the following:
- Executive traits
Therefore, compensation agreements pertain to such unobservable traits, which affects performance, value, and company behavior. To contend with the research issue, researchers use a new method outside of a firm’s control (ex. exogenous) and have limited executive pay to a binding upper limitation. Such a shock allows researchers to rely on standard capital-markets short-window event-study methods, which mentions that inefficient markets and investors and fully account for all information regarding the effects of the shock and incorporate the principles into the market price.
Such a method allowed researchers to examine different predication regarding the maximization value theories and rent extraction theories in a short event window surrounding the shock. Under a maximization value theory, compensation agreements a usually maximize a firm’s value, and efforts to limit such contracts in the form of executive pay would be counterproductive and would reduce a firm’s value. However, under rent extraction theory, executive pay limits lower rent extraction and results in a firm’s value increase.
To know more about compensation contracts, submit your legal inquiry to our UpCounsel marketplace. UpCounsel’s lawyers have graduated from some of the most prestigious law schools in the county and will help employers negotiate salary and bonuses with their employees. Further, our lawyers will be by your side if you find yourself in a legal quagmire, and they will provide assistance if you come across any court proceedings against you.