Corporate Tournaments and Executive Compensation - Research Paper Example

Executive Compensation Introduction Like any other field of study, the field of management science has also a huge list of ongoing debates, which have attracted various experts to take either sides and present their views. Over the years, these debates and the views of these experts has played an all-important role in shaping the field and allowed the students to gain new perspectives (Mishra, McConaughy & Gobeli, 2000). One of these debates is about the sky rocketing compensation levels of CEOs and other executives of American companies. The debate about high executive compensation has been in the spotlight in United States since industrial revolution. However, it was during the great depression that this news and discussion made the headlines. Since then, this debate has always received widespread during all economic recessions. Following the pattern, as the financial crunch and economic recession hit the United States in 2006-07, this debate again reached its peak because the masses started questioning the perceived wide gap between the salaries of an average employee and the executives. Critics of high compensation believe that this is one of prime reasons of increasing inefficiencies, recession, and increasing income inequality in United States. On the other hand, proponents of high compensation believe that these pay levels are a result of market and competitive forces and external forces such as the government, watchdogs and others should have no right to interfere in how much the boards of willing to pay their executives. The thesis statement around which this paper that revolve is that “executives pay is sky rocketing and there is no rational and logical thought to allow these pay levels to increase further if we want a way out of this recession and prevent future recessions” (Mishra, McConaughy & Gobeli, 2000). Review of the Literature There is a long list of experts, which have explored this issue from time to time and offered their insights. Views and arguments of Kalpan, Sigler, Kay, Hayes, Mishra, McConaughy, Gobeli, Graham, and others have under discussion below. Experts like Steve Kaplan have gone to say that the current level of CEO compensation reveals that most good CEOs, in fact, are underpaid. They compare the pay of CEOs with investment bankers, hedge fund managers, equity investors, lawyers, and others. Since 1990s, there has been steady increase in the salaries of above-mentioned professionals but the pays of CEOs and other executives has not risen with the same percentage. Furthermore, out of the top 0.1 percent people in the United States arranged according to the gross income, only 3 percent of them were CEOs and executives of companies. Furthermore, in the year 2007, “top 20 hedge fund manager bagged more than three times the pay earned by the salaries of all S&P 500 combined” (Hayes & Schaefer, 2009). Proponents of this school of thought strongly believe that companies will have to take bold steps in order to retain their executives because many smart CEOs have already started shifting to Wall Street to take positions at private equity firms (Hayes & Schaefer, 2009). In order to defend the position of CEOs being overpaid, other experts have gone on to accept that executives and specifically, CEOs are overpaid but it is not because of the work that they do but because their job is to inspire people. The reason behind providing CEOs with the fattest checks is to ensure that it keeps other people in the company motivated (Kay & Putten, 2007). Everyone dreams to become a CEO or an executive some day and people dream about the same because they know the compensation levels. People look at executives, their cars, houses, clubs, salaries, benefits, lifestyles and that is what keeps them motivated to stay with a company and put in their best effort into their jobs hoping that within a decade or so, they would also be able to reach that dream position. Economists call this, as the “tournament theory” which explains that people are paid not based on their actual performance but on the basis on their relative performance (Mishra, McConaughy & Gobeli, 2000). Important here to note is the fact that at least in a country like United States where employee loyalty is comparatively low, individualism is high, individual greed levels are high and power distance is low, one needs this huge pay gap in order to attract and retain the talent in the management levels. If companies decide to flatten this gap then it would pull away the incentive, which millions of workers see to go the extra mile for increasing their productivity and pleasing their bosses (Graham, Roth & Dugan, 2008). A recent research conducted by Sigler (2011) indicated that there is a positive relationship between the compensation of CEO and the performance of the company. The research (Sigler, 2011) examined 280 firms, which are listed on the New York Stock exchange and it examined their performance from 2006-2009. The research revealed that the higher the compensation of CEO, the better was the performance was of the company. Important here to note is that “performance” was measured in terms of Return on Equity (ROE) and Return on Investment (ROI). Furthermore, there was also a correlation amongst the size of the firm and above-mentioned variables. Critics accuse the executives that they are the most important reason why companies are suffering even in the time of economic downturn because the CEOs cannot let their fat checks out of their hands. However, these critics easily avoid the countless examples of executives of various companies, who, repeatedly, have come forward to sacrifice their pay in order to share the pain with their employees. Nucor Steel has a strong plan, which ensures that executives receive lesser salaries during the time of economic downturns and when the company is need of funds (Conyon, Peck & Sadler, 2001). David Neelman of Jet Blue Airways was generous enough to donate his entire annual salary for the employees, which were in immense need of cash. Roger Enrico of PepsiCo also made a great example when he stepped up to donate his entire one-year’s salary to a special fund of the company, which ensured that the children of the lower level employees of the company get access to education (Graham, Roth & Dugan, 2008). When PeopleSoft merged with Oracle, former CEO of the company David Duffield decided to give cash grants to the employees that had to lose their jobs (Conyon, Peck & Sadler, 2001). These grants equaled their salaries for the next three months. The point here is that while discussing the issue of executive compensation, the critics present executives of companies as “greedy monsters” who would go to every possible limit to ensure that their pay remains increasing year after year despite of the performance of the company. These people avoid these many examples where CEOs have come forward to literally “share the pain” with their employees thus creating great examples (Gabaix & Landier, 2008). Discussion of the Issues Furthermore, proponents of high executive pay believe that the debate of executive pay should not be happening in the first place. It is not like as if there is no check and balance on the CEOs, the board of directors is always there to ensure that the CEOs earn more only if they bring more to the company. There are so many instances where the boards have fired the executives for being a burden on the company (Lipman & Hall, 2008). However, if boards are ready to pay millions of dollars to specific individuals then they must be worth it. For example, recently, the Royal Bank of Scotland, which is operating under the control of UK government, hired a CEO with a package of 16 million US dollars. Even the United States government paid 10.5 million US dollars to a CEO for AIG, which is under the control of US government. People earn what they deserve and that is even true for the President Obama’s administration. Larry Summers made 8 million US dollars, which is more than the average S&P 500 CEOs salary, for his speeches and working part time for a hedge fund. Working as a partner at the law firm, Eric Holder was able to make more than 3 million US dollars (Hayes & Schaefer, 2009). The point here is when the critics accuse the private companies of wasting money and overpaying CEOs and when they ask the government authorities to come to their rescue, the fact is that even the government is ready to pay in millions if they feel that millions is what is required to attract and retain the talent. Paying less to the CEOs and others executives of the company would be a huge gamble for any company to take. Successful companies, which have been able to execute their strategies and reap benefits out of it, were the ones, which were able to retain their CEOs for a long-term period. Consider the example of “Steve Jobs for Apple, Jack Welch for GE and Gordon Bethune for Continental Airlines and others” (Gabaix & Landier, 2008). These leaders turned around their companies and most of the credit for the same goes to their leadership, vision, and strategy. Without any doubts, they were paid in millions but if it were not for these executives then these companies would never ever been able to pose those billions in revenues and many millions in profits. Therefore, the point here is that the compensation that CEOs receive represents that this is their worth to the company and there is no limit to how much the owners, shareholders and board of directors are ready to pay the attract and retain the best and qualified executives in the market (Mishra, McConaughy & Gobeli, 2000). Proponents of high executive pay also defend their position by highlighting the basic economic models and theories of United States of America. The founding fathers of the country wanted to make it a purely capitalistic state where free market economy would be the order of the day and market forces would determine all the economic variables (Bebchuk & Fried, 2006). In a capitalistic economy like the United States, government intervention in the corporate world and market is a recipe for disaster and strongly discouraged. Therefore, the United States government and other institutions should not poke their nose in the matters concerning the private investors until and unless that they are causing a direct harm to others (Ferracone, 2010). Within a few months of taking over the office, even President Obama showed the world that how important it was to put a cap on the executive compensation. Even in the times of recession, many CEOs pocketed more than 50 million US dollars in the year 2007. They include “John Thain (Merrily Lynch), Richard Adkerson (Freeport-McMoRan Copper & Gold), Leslie Moonves (CBS), Lloyd Blankfein (Goldman Sachs), Michael Fries (Liberty Global) and many other CEOs” (Ferracone, 2010). The President decided that it was important to limit the executive pay by 0.5 million dollars so that public trust could be restored since the government is helping many companies in form of bailout packages and they are paying millions to their executives (Ferracone, 2010). Proponents of high executive pay fail to recognize the fact that along with external forces, there are internal factors as well which needed to be taken into consideration while deciding on the executive pay. Many companies, while trying to achieve external equity for their executive compensation plans, lose sight of internal equity (Gabaix & Landier, 2008). The gap between the pay levels of the executives and the employees and increased so much that it is negatively affecting the employee morale. Furthermore, leaders and executives, who bag millions of dollars in salaries and countless other benefits when their employees find themselves in troubled situations since their pay increases cannot keep up the pace with rising inflation, not only fail to inspire people but they create a sense of discontent amongst the employees. The increasing gap increases the gap communication and understanding gap between the leaders and thus creates problems in strategy execution (Lipman & Hall, 2008). Proponents of high executive compensation believe that sky rocketing executive compensation is a result of market forces and in a free market capitalistic economy, there is no rational for distorting these market forces. However, statistics reveal that this not the case. In 1965, the ratio between CEO pay and the average pay of company’s employees was 24:1. Towards the end of the year 1980, the ratio had increased to 30:1. Ever since then, there has been tremendous increase in this ratio and in the year 2000, it peaked at 300 to 1. During this decade, this ratio even went on to touch the level of 400:1 but recession and the President Obama’s executive compensation cap has brought the ratio back to somewhere near 300:1. If these forces are completely driven by market or competitive forces, then one can interpret, 46 years ago, CEOs were not that important to the company as they are today or maybe, over these years, the supply of talented, skilled, and qualified CEOs has dropped significantly. Neither of these appears to be true. Furthermore, this pattern is only visible in United States. Executives in other emerging economies such as China, Japan, Brazil, and others have much lower levels of compensation and salaries (Graham, Roth & Dugan, 2008). Statistics reveal that the CEO of an American company earns 225 percent more as compared to the CEO any other company from the 13 largest industrial economies. Statistics indicate that the pay of CEOs working at the 20 largest companies in the United States increased by more than 20 percent where the pay of average worker in the United States increased by a mere 2.1 percent which is the smallest in the past decade (Ferracone, 2010). Another important argument in this regard is the fact that executives enjoy great deal of authority in their companies. At most occasions, either directly or indirectly, they decide their own compensation levels which is not according to the code of ethics. Therefore, it becomes important to put a cap on the level to which they can increase their salary (Lipman & Hall, 2008). Conclusion Executive compensation in the United States and the rest of the world needs immediate restricting. In the coming years, when resources would be even scarcer and there would be even more fierce competition over these scarce resources, it would be important to use these resources effectively and efficiently. Cash available at the disposal of the companies is also a precious resource, which must be used to motivate employees and grow the company, rather than filling the pockets of CEOs and others, employees envy of them. Whether through legislation or through individual efforts, stakeholders of the companies should come forward to put caps on executive compensation tie them more closely to the organizational performance. To sum up, as mentioned earlier in the paper as well “executives pay is sky rocketing and there is no rational and logical thought to allow these pay levels to increase further if we want a way out of this recession and prevent future recessions” (Mishra, McConaughy & Gobeli, 2000). References Bebchuk, L. A., & Fried, J. M. (2006). Pay Without Performance: The Unfulfilled Promise of Executive Compensation. Harvard University Press. Conyon, M., Peck, S. & Sadler, G. (2001). “Corporate tournaments and executive compensation: evidence from the UK.” Strategic Management Journal. Volume 22, pp. 805–815. Ferracone, R. A. (2010). Fair Pay, Fair Play: Aligning Executive Performance and Pay. John Wiley and Sons. Gabaix, X., & Landier, A. (2008). “Why has CEO pay increased so much?” Quarterly Journal of Economics. Volume 123, 49-100. Graham, M. D., Roth, T. A., & Dugan, D. (2008). Effective executive compensation: creating a total rewards strategy for executives. AMACOM Div American Mgmt Assn. Hayes, R. M., & Schaefer, S. (2009). “CEO pay and the Lake Wobegon effect.” Journal of Financial Economics. Volume 94, pp. 280-290. Kay, I. T., & Putten, S. V. (2007). Myths and realities of executive pay. Cambridge University Press. Lipman, F. D., & Hall, S. E. (2008). Executive Compensation Best Practices. John Wiley and Sons. Mishra, C. S., McConaughy, D. L. & Gobeli, D. H. (2000). “Effectiveness of CEO pay-for-performance.” Review of Financial Economics. Volume 9, pp. 1-13. Sigler, K. J. (2011). “CEO Compensation and Company Performance.” Business and Economics Journal, Volume 2011, pp. 1-8. Read More