Growth in Executive Remuneration in Different Economies - Essay Example

Student Name: (please insert here) Student Number: (please insert here) Course Name: (please insert here) Course Code: (please insert here) Assignment Number/Title Year of Student(s): (please insert here) Due Date Word Count: 1590 Area of Learning Skill: Executive Compensation Introduction Corporate world is currently dealing with the collapse of housing market bubble, the ensuing global recession as well as a number of traditional assumptions like the primacy of shareholder value maximisation and lax la issez-faire banking oversight which apparently are under threat. Other assumptions that have been attacked is the infallibility of the well-designed remunerations that are meant to favour executives especially in publicly owned corporations, where theories such as agency has made rewards reached historical highs, instigating not great performance but outsized risk taking motives. The most prevalent argument concerning the high remuneration for executive officers has been the one pegged on economic theory as well as economic efficiency. While theories argue that remunerations for executive officers are justified as they form an incentive that motivate them to high performance, economic efficiency posit that such remunerations are not reflected in the recent growth and performance of these organizations. This paper critically assesses growth in executive remuneration in different economies and how it is justified with regard to economic theories. There is consensus among economic experts and business academics that the effectiveness of incentive remuneration in resolving the agency problems is not justified (Adams et al., 2005). Additionally, Lublin and Hechinger (2002) argue that while executive remuneration is seen as a potential solution to agency problems, it is a matter of fact, part of agency problems. To underscore the theoretical and practical evidence of the findings, in 2008, compensation made to the CEO in organization that made up the 1500-company ExecutiveComp dataset compensation of the CEO reduced corporate profit by averagely 4.72% (Balsam 2009, p. 262). Additionally, basing on the powerful incentive provided by stock options in Australia, there is a chance that there will be temptations to inflate stock prices artificially. Nichols and Subramaniam (2001) researched the relationship between high levels of CEOs incentive compensation and chances of financial misrepresentations. The conclusion from the study manifested that the more corporate world was increasing remunerations for the CEOs the more there was increase in malfeasance. To understand this finding, this study connects it with underpinnings of prospect theory and a case study in Australia. Modern agency theory which is actually the theoretic principle for a number of compensation negotiations has been founded on the principle that CEOs are egoistic and therefore should be rewarded through incentives to act in the best interest of the organisations. On the one hand, this theory contradicts the findings by Nichols and Subramaniam (2001). On the other hand, this theory is only based on the ideas that CEOs should be regarded as ‘homo economicus.’ By homo economicus this study means that they are perfect managers who are able to maximise gains across all decisions. Looking at agency theory, prospect theory and the study by Nichols and Subramaniam (2001), it is noted that there is confliction of ideas. The conflict is that CEOs must be rewarded to achieve certain performance. Such belief was witnessed in Coca-Cola Company between 2012 and 2013 where the CEO, Muhtar Kent revised his payment and those of other senior employees in the Company. As it was based in Atlanta Georgia, Muhtar Kent responded to the mounting pressure that was coming from Wintergreen Advisers who called it a "raw deal" especially for shareholders, more importantly, in light of the its slowing growth (Jensen and William, 2014). However, looking at the economic growth in Australia as researched by Bebchuk and Fried (2004), the rush to restructure corporate firms to align with increasing demand for equity compensation is not justified. Ideally, it remains that one of the results of true and a fair representation of opportunity is that well suited person should be given the job. Granted, Rawls is in support of open vacancy not because the individual would better ‘suit or deserve’ the corresponding remunerations, but since such a process is necessary or essential to the Rawlsian conception of what is supposed to be just and valuable to people. This study turns its attention to the theory of equilibrating (supply and demand arguments) which tend to argue against high corporate remunerations for CEOs. As it has been researched by Gabaix and Landier (2008), he connect this theory with economic theory postulating that where there are demand in resources, there will be rise in price for the same resources. This can be equated to the U.S. corporate scandals that touched on Tyco and Enron with stellar performances from these Companies facing criticism (Gabaix and Landier 2008). Additionally, in 2003, Apple Computer CEO Steve Jobs got increment on salary to $1 was met with fierce criticism as the performance of the company was not commensurate to the increase. However market will adjust to suit such changes. Where this does not happen then it will be a case of rent-seeking behavior by resource owners as well as uncompetitive market. Analyzing what John et al. (1999) postulate with regard to the thesis statement in this study, it is like demand for corporate CEOs is on rise. There has been drastic rise in supply (in this number of CEOs educated, promoted or trained at given period of time). If this is what Gabaix and Landier (2008) is trying to communicate to corporate world through the theory of equilibrating then the supply of labour (CEOs) has increased drastically to an extent that some corrections should be made concerning the remunerations of CEOs in their quest as the source of resource (labour). To reverse burden of proof to scholars such as Marianne and Sendhil (2001) who have justified huge remunerations to CEOs, this study shifts to empirical evidence. World Bank researched on the relationship between CEOs pay and economic growth within the same organization where the CEO is heading, share market index returns and GDP growth rate within a specified period (Productivity Commission Inquiry Report (2009). Looking at figure one it is noted that the pay for CEOs in the selected countries is larger than average income of the organization with CEOs from United States being the outlier. Figure 1: CEOs Pay Compared with Average Income Source: Productivity Commission Inquiry Report Interpreting the figure above differently (in case this we consider the national GDP growth rate per capital and the CEO remuneration), it can be deduced that GDP growth rates for a given country can be inversely proportional to remunerations given to CEOs. That is, the higher the remuneration, the lower a country or a firm can realise economic growth rate. At best, it is worth concluding that there is no evidence, from research conducted by World Bank that CEOs increase in pay leads to higher national or firm’s economic growth. Just like Brin (2002) did, proponents of high remunerations for CEOs may argue that figure 1 was mainly measured against national GPD rather than corporate returns (their point of departure being that national GDP growth can be affected by myriad of factors beyond CEOs). To dispute this notion, researches such as Harris and Bromiley (2003) have statistically shown that average share market gains in Australia for over ten years for publicly listed companies if compared with pays given to CEOs, there is no obvious link apparently showing that higher CEO remuneration leads to higher share index returns. On contrary, the best performed share markets seemed to have been where CEOs were paid averagely low. Contrariwise, executive compensation and product quality believe that huge remunerations to CEOs is justified. Douglas Cowherd and David Levine seemed to have been among first scholars to empirically present evidence suggesting that corporate’s reward system to CEOs is directly linked to product quality (Jensen, 2002). Though what Douglas Cowherd and David Levine present has generated enormous debate, their evidence from 102 publicly listed companies in Australia, Canada, United States and England shows that well-structured remunerations programme that motivates CEOs is directly linked to quality of output. This is supported by Nichols and Subramaniam (2001) who finds that performance contracts that CEOs sign should come with good remunerations otherwise value that the contract is supposed to create may be lost. This notion was exemplified by the utterance made by former Citibank CEO, Charles Prince saying, ‘provided the music is playing, we have to get up and dance. We are still dancing’ (Gabaix and Landier, 2008 p. 28) Charles Prince justified the fact that in a traditional agency theory model, CEOs should be rewarded for averting perceived risks and profits made. Conclusion Executive compensation has not been exhausted in the study above. If anything, it continues to be a controversial subject that has attracted among scholars. Based on the theories reviewed, one aspect remains poignant; that contract theory can predict shareholders to be using pay to provide incentives to CEOs so as the CEOs can focus on the maximization of long term value of their firms. Secondly, the premise held by David Levine and Charles Prince that huge remunerations is justified is not evidence based as there no component in the remunerations that rewards the process of effective risk aversion or management. If there is any evidence as provided in the essay is that theoretically, the managerial power views CEOs as managers in control and as such in-charge of pay-setting process. It is from this conclusion that theories and empirical evidences gathered posit that the problem even emanates from committees and boards who provide CEOs with excess power to execute compensations. This results in one consequence; executive compensation has some consequences for corporate governance therefore future research should explore on ways of improving compensation arrangements as what is done at the moment deviate from optimal contracting. References Adams, B., Almeida H, and Ferreira D, (2005) “Powerful CEOs and their Impact on Corporate Performance” Review of Financial Studies, Vol 18 Issue 4 September 2005. Balsam, Steven. 2009. An Introduction to Executive Compensation (Academic Press). Bebchuk L, and Fried J. (2004), Pay Without Performance: the Unfulfilled promise of Executiv Compensation, Hardvard University Press, Cambridge Massachusets. Brin, W. (2002). Exit strategy: directors are starting to rethink lucrative severance payouts they give to fired CEOs. Wall Street Journal. April 12, R15, New York. Gabaix X., and Landier A. (2008). “Why Has CEO Pay Increased So Much?,” The Quarterly Journal of Economics, MIT Press, vol. 123(1), pages 49-100. Harris, J. and Bromiley, P. (2003). Incentives to Cheat: Executive Compensation and Corporate Malfeasance. Paper presented at the 2003 Strategic Management Society International Conference, Baltimore, MD. Jensen, M. (2002). Value maximization, stakeholder theory, and the corporate objective function. Business Ethics Quarterly, 12(2): 235–256. Jensen, M. and William M. (2014). “Theory of the firm: Managerial behavior, agency costs, and ownership structure,” Journal of Financial Economics 3, pp. 305-360. John M. Abowd and David S. Kaplan (1999) ‘Executive Compensation: Six Ques- tions That Need Answering’, Journal of Economic Perspectives 13(4), pp. 145-168 http://www.jstor.org/stable/2647017 Lublin, J. S. and Hechinger, J. (2002). Forced exits can pay richly for some CEOs. Wall Street Journal, June 5, New York. Marianne Bertrand and Sendhil Mullainathan (2001) ‘Are CEOs Rewarded for Luck? The Ones without Principals Are’, The Quarterly Journal of Economics 116(3), pp. 901-932, http://www.jstor.org/stable/2696421 Nichols, D. and Subramaniam, C. (2001). Executive compensation: excessive or equitable? Journal of Business Ethics, 29: 339–351. Productivity Commission Inquiry Report (2009) ‘Executive Remuneration in Aus- tra http://www.pc.gov.au/__data/assets/pdf_file/0008/93590/executive-remuneration report.pdf Read More