Boards of Directors and Executive - Case Study Example

Executive Pay: A Cause for Concern Introduction There has been a bevy of speculation recently regarding executive salaries and compensation in general for corporate officers. One aspect of this scenario that has received a great deal of attention is related to executive pay differences associated with various types of organizations be it privately owned or public. It appears as though these executive pay issues are often at the forefront of the news when executives are involved in some type of litigation that result in compensation related issues; or simply a news flash about exorbitant executive compensation. The topic of executive pay has received significant attention in recent days as evidenced by an explosion of interdisciplinary literature ranging from law to accounting to organizational behavior and strategy. While there is diversity across industries, sizes of organizations and countries, executive pay includes the common features of base pay and bonus based on performance. CEO compensation has become one of the most important issues of concern in the field of corporate governance. With ever increasing economic activity and companies transcending all boundaries, geographic, economic and technological, the person in charge of steering the company has been thrust into focus. Typically, huge compensation packages were a phenomenon of the golden days of dotcom glory. The period of Internet boom may safely be termed the era of exorbitant pay-outs. The Internet made millionaires of people in a matter of days. In the Internet-rush' of the late 1990s, a number of small companies mushroomed redefining the principles of economies of scale and scope. The CEOs (as well as the employees) of dotcoms often burnt the midnight oil trying to float their talents. For their efforts, they were compensated handsomely, when the company took off and reaped rewards. However, even after the burst of the Internet bubble and the decline of the software industry from its top position on the list of the most happening industries, huge pay-outs have remained. A quick recap of the origin of CEOs will give us a better understanding of the topic. When economic systems evolved from sole proprietorships to the company form of business, a need for a distinction between the owner of the resources and their managers arose. In some cases, owners stopped playing an active role in managing the business resources and turned them over instead to paid managers. These paid managers acted as agents of the owners and took up the responsibility for the success or failures of the business. As businesses grew in size and scope, the manager attained the glorified title of a CEO. The compensation system also became more complicated, evolving from a simple salary to benefits like bonus, perks and stock options. As time passed, the compensation packages grew in size until they attained such astronomical proportions that people began feeling the need for some control. This leads us to the question of whether CEOs merit the huge compensation they receive or not. In the US, historically, CEO's in "utilities earn significantly lower levels of compensation than their counterparts in other industries, while CEO's in financial services earn higher pay" (Ashenfelter, et al, 1999, p. 5). Yet the relationship between firm size and executive pay is weakening. A comparison of executive pay in 23 countries shows that executives in the US receive a greater proportion of their pay from bonuses and incentives than from base salary. Another reason for high CEO compensation was the fact that a major portion of their compensation package consisted of stock options and stock grants. In some cases, nearly two-thirds of the CEO's pay assumed the form of stock options. Some companies offered options packages to compensate for low salary and risk associated with the company, especially in case of a start-up company. Stock options had emerged as one of the most important factors, which made the CEOs salaries in big companies in the US to swell to almost 458 times the wages of an average worker. According to analysts, downsizing or lay-offs too were the reasons for high CEO compensation. Sometimes, when a large number of employees were laid-off or retrenched from a particular company, the money thus saved was used in giving more increments to the CEO concerned. The corporate boards felt that, since the CEOs were entrusted so many key responsibilities, it would be unfair to criticize them when they received a bonus or high salary, more so when the company was doing very well. Money was the greatest factor in driving CEOs to attain higher levels of productivity. According to an HR analyst, "the performance of the US economy during the 1990s proved the fact that higher compensation motivated higher productivity, which in turn led to all-round development of the economy" (Jensen, 1976, p. 26) Companies argued that high CEO compensation was also dependent on the market conditions of a particular industry. Several companies were willing to pay large compensation packages to attract the best CEOs in the industry. According to a study conducted by a research organization called Venture One, the competition for tapping the right executive talent had increased tremendously over the recent years. High compensation for CEOs was justified if they performed well and enabled the company to grow in spite of an economic downturn. Though the high compensation package for CEOs was justified by some companies and corporate board members, it was not welcomed by public investors and other stakeholders. Some of them felt that such high compensation packages added to the company's burgeoning costs. They argued that these packages did not ensure loyalty or minimize the turnover of CEOs and the top management. Highly paid CEOs might as well quit the job as low paid CEOs would. They also felt that high compensation to CEOs need not necessarily lead to improved performance or ensure steady increase in stock prices. In fact, it only served to increase the inequalities of income between the top executives and other employees of the organization. Critics of high CEO compensation argued that stock options were not effective in attracting the best of management talent or arresting the high CEO and top executives' turnover. They said, when a company was not performing well, the CEO's compensation should not be hiked. However, there were instances where, in spite of the poor performance of the company, the CEO's salary was raised significantly. For example, in 2001, Lucent Corporation spent millions of dollars in retaining its top executives in spite of poor financial performance, falling market shares and stock prices. A similar case was reported about Polaroid Corporation, which later withdrew its plan to pay bonuses worth $5 mn to their top executives in spite of poor financial performance, after employees of the company strongly protested (Hallock, 1997). Critics also complained that the CEOs were making a good amount of money in the name of downsizing, at the cost of thousands of hardworking and loyal employees. Chuck Collins, Co-Director of United for a Fair Economy12 said, "For ordinary Americans, there is no greater symbol of betrayal by corporate America than CEOs cashing in as they lay-off workers. The pain of corporate downsizing should not be someone else's gain." The Debate Intensifies The global economic slump during the beginning of the 21st century further intensified the debate on high CEO compensation. Analysts felt that while corporate revenues and net profits were declining and share prices falling, there was no reason why CEOs should get a raise in their compensation. According to a study conducted by Forbes13 in 2002 for non-US based companies, 17 specific instances were reported where a CEO got a raise in compensation in spite of falling stock prices and lower net incomes (Sirkin, 1996). Analysts thought that paying high compensation to CEOs especially during a boom in the economy was not a right decision. They argued that the high profits and good performance of the stocks of a company during the boom resulted from the environmental and other macroeconomic variables, over which a CEO had no control. Hence, higher profits and stock prices were not the correct indicators of a CEO's performance. They further argued that the success of a company depended equally on the performance of the CEO and the employees and hence, raising the salary of the CEO, and not that of employees, was not fair. A study conducted by the Academy of Management Journal revealed that the quality of team performance was lower when the gap between the highest and lowest paid employees in a company was maximum (Murphy, 1997). Conclusion Though the debate continued, a need was felt to design the CEO compensation package in such a way that it always aimed at maximizing the shareholders' wealth, which is the ultimate aim of any corporate organization. Experts felt that the package must be designed according to the CEO's individual performance as well as the extent of his/her contribution to the company's overall success, growth and development. While the compensation package was not too low or too high, it was supposed to be lucrative enough to attract and retain talented people in the top management. Some experts suggested that there should be some restriction on the total compensation paid to the CEO by limiting it to a maximum of 30 to 40 times the salary of an average worker in the company, while the additions to the CEO's salary due to downsizing of the rest of the staff must be minimized or completely eliminated. References Ashenfelter, P. Orley, Richard G. Layard and David Edward Card (1999), Handbook of labor economics, North-Holland Hallock, K. F. (1997) Reciprocally Interlocking: Boards of Directors and Executive Compensation, the journal, Financial and Quantitative Analysis Jensen, C. Michael and William H Meckling, (1976) Theory of the Firm: Managerial Behavior, Agency costs and Ownership structure' Journal of Financial Economics Murphy, J. Kevin (1997), Politics, economics and controversy over executive compensation, The Aei Press Sirkin, Michael S. And Lawrence K. Cagney (1996), Executive compensation, Law Journal Press Read More