CEO Compensation - Literature review Example

CEO Compensation CEO Compensation Introduction American executive compensation has been a point of concern and an agency problem in most companies. This is because the wages of average workers have stagnated as well as the economy levels. CEOs excess compensation results from ethical lapses. Many senior executives fail to focus on ethics for a long period. This results in managers concentrating on their own needs other than the needs of the company, shareholders, employees and their customers. This affects the company’s decision-making processes, which have long-term implications. Chadler (2009) argues that leaders who have acquired strong ethical cultures make mature and intelligent decisions for the well-being of the company, shareholders, employees and the customers. However, companies that have less emphasis on ethics excessively reward themselves with extra compensations. Sigler (2011) assert that executives earn special benefits, such as stock options, severance pay, bonuses, life insurance, retirement plans among others. They earn such benefits at the expense of shareholders. Question One Cognitive dissonance is present among CEOs who have unethical characteristics, such as over confidence and over optimistic. This is a situation where managers suppress and reconstruct company decisions to protect their images. Chadler (2009) comments that managers who lack moral values, character and behavior are greedy, selfish and are involved in cheating. Managers use this tactic to deceive themselves and escape from attending their responsibilities. Vocational success experienced by unethical leaders, makes them lose focus, have privileged access to people and information, have no control of the organization’s resources and manipulate the outcomes. These leaders show unethical characteristics that lead to emptiness and personal isolation. The vocational success causes unethical leaders to exempt themselves from certain company protocols and expect certain special rewards for their work. Most of these unethical CEOs end up in denial. Unethical leaders lack interpersonal skills, abuse powers bestowed to them and lack accountability. Inadequate ethical behaviors among the CEO s leads to lack of charisma (Chadler, 2009). Unethical charismatic leaders are the biggest obstacles in decision making since they challenge the decisions made by other leaders and followers, complain, and have independent views. They abuse their powers to gain excessively from the company without considering the needs of the shareholders. Chadler (2009) explains that if the CEOs considered the above compensations second, the board of directors will have enough time to make mature decisions. Bedchuk and Fried (2003) argue that financial economists use optimal contracting approach to maximize their shareholder values through adding extra money to the managers. The managerial approach demonstrates that compensation of the executives should be reduced since managers who influence their pay place excess costs on shareholders. This action disorients the performance of the companies through decision-making. Question Two Executive’s compensations on risks taken should be rewarded depending on the accountability of the ethical leaders. Chadler (2009) adds that unethical leaders are greedy and do not take company risks on capital entrusted to them. Unethical leaders use the powers given to them to exploit capital owners and reward themselves regardless of whether the person has performed or not. They use excess compensation to go for luxurious tours; thus, reducing time to make mature decisions, bargain on the interest of their shareholders, and take risks. Singler (2011) argues that board members influence the base salaries of CEOs and comprise 11.2 percent of their compensation. These include cash bonuses paid at the end of the year as performance incentives for reaching certain set goals. Stock options also act as CEO incentives. These are equity compensation used to motivate the top executives to bargain for the interests of the shareholders (Correa, 2013). These acts as a gain to the CEOs since their income from such gains are taxed as ordinary income but not long-term capital gain. Bedchuk and Fried (2004) argue that managers take advantage of the powers given to them to secure rents. The CEOs have powers to influence the boards financially. The CEOs payments to shareholders are low and the directors must follow them since their economic incentive is little. Arms length contracting enables the managers to source more money from the workers below them. Company risks are high to investors than other workers. CEOs and other top executives obtain gains from collegiality forces, respect for the top most officials, and team spirit from board members using managerial power model (Bedchuk & Fried, 2004). Friends of the executives pay are also favorable. The executives have the ability to camouflage through limiting critics and hiding to obtain rents. These practices influence decision making because the executives are responsible for making decisions. This influence firms to adopt friendly decisions and policies, which might not be efficient and compatible with the business. On the other hand, critics from the shareholders lead to campaigns that force the leaders to adopt the proposals given to them by the shareholders. Most of the executives use the capital entrusted to them to gain retirement benefits, compensation arrangements, and interest free loans among others (Holmberg & Schmitt, 2014). This leads to ratcheting of the pay levels among the executives, which also increases their compensation. This happens even if there is no improvement in the managerial performance. When there is a boom in the economy the pay of the CEO skyrockets. This pay can be reduced through direct regulation and taxing their salaries. Policies to have different tax rates to the highly paid will be of great benefit to the shareholders. Question Three Ethical executives should be richly compensated after fulfilling their fiduciary duty to others because they prevent the business from collapsing. Black (2001) explains that fiduciary rights of the board of directors to shareholders are loyalty and care, discloser, and protection in case of selling the company. The executives should be richly compensated after fulfilling their fiduciary duties. Aviram (2013) argues that the directors are responsible for ensuring that the processes of the business run in a fair manner to prevent damages. Question Four CEO and managerial compensations, incentives in bank regulations and policies should be systematized to endorse risk taking business and investments. This is because the banks will offer loans to the investors at a lower interest rate and generate interest free incomes. Innovations in the financial markets and information technologies have acted as new opportunities for savers, depositors, and borrowers. Federal deregulation gives banks the capability to engage in non-banking products, such as brokerage, banking, insurance, sales investment banking, and underwriting. Young, Pang and Yan (2010) argue that the emergence of scale-incentive model often referred as transaction banking is based on new information channels(credit bureaus), generating noninterest incomes, and new processes of finance (asset securitization). Banks issue securities to finance the large amount of loans on the balance sheet. Securitization process gives banks the opportunity to sell illiquid loans and fund additional loans using the proceeds. As a result, the banks earn income fee from initializing the loans, securitizing it, and servicing it. According to Young, Peng and Yan (2010), this process reduce the benefits earned by mortgage-backed securities (MBS). Through this process, the MBS only earn interest payments and principal repayments. The banks may also hold MBS portions and provide agreements to MBS investors. This reduces high payments made to third party financial investors exposed to the risks and earns high returns without generating the loans themselves. Some firms offer benefits, such as corporate jets and prestigious clubs membership. Gristen, Weinbaum, and Yehuda (2008) argue that those benefits originate from the diversion of firms resources by the CEOs and managers. This leads to low returns to the shareholders. The researchers argue that these benefits are systemized in a way that they motivate the executives to put more effort into their work. Organizations should generate cheap incentives by offering benefits than providing incentives inform of compensations. These benefits will align managerial incentives with the value of shareholders. According to Frank (2006), the government requires public companies to disclose pay ratios of the workers and the CEOs. References Aviram, A. (2013). Officers’ fiduciary duties and the nature of corporate organs. University of Illinois Law Review, 763-84. Bedchuk, L.A., & Fried, J.M. (2004). Pay without performance, the unfulfilled promise of Executive compensation, Part 11: power and pay, 1-71. Bernstein, S. C. (2009). Executive compensation: How does pay influence decisions and governance? Columbia Business School, 1-24. Black, B.S. (2001). The principal fiduciary duties of boards of directors. Presentation at Third Roundtable on Corporate Governance, 1-13. Chandler, D. (2009).The perfect storm of leaders’ unethical behavior: A conceptual framework. International Journal of Leadership Studies, 1 (5)1-25. Correa, R., & Lel, U. (2013). Say on pay laws, excecutive compensation, CEO pay slice, and firm value around the world. International Finance Discussion Papers, 1084, 1-55. Frank, D. (2006).Why CEO-to worker pays ratios matter for investors. AFL-CIO Office of Investment, 1-7. Gristen, Y., Weinbaum, D., & Yehuda, N. (2008). Benefits and excess: Evidence from the new executive compensation disclosure rules. Johnson Graduate School of Management, Cornell University, 1-47. Holmberg, S., & Schmitt, M. (2014). The overpaid CEO. Retrieved from http://www.democracyjournal.org/34/the-overpaid-ceo.php?page=all Sigler, K.J. (2011). CEO Compensation and company performance. Business and Economics Journal, 1-8. Whelton, R.S. (2005). Effects of excessive CEO pay on U.S society. College Of Business and Management, 1-7. Young, R., Peng, E., & Yan, M. (2010). Executive compensation and business policy choices at U.S commercial banks. Research Working Papers, 10(2), 1-57. Read More