Executive Compensation - Coursework Example

Executive Compensation Recently, the executive compensation in the United s has been the focus of public scrutiny as populist argument points tothis factor as the culprit behind the financial troubles of large American corporations. The political campaign of the then presidential aspirant Barack Obama was, for instance, seriously threatened when he was linked to Franklin Raines, the former Fannie Mae CEO , who was reportedly compensated $90 million from 1998 to 2003. Understandably, this is an important issue in America amidst the ongoing financial recession wherein thousands are losing their jobs. There is an ongoing public indignation over the idea that there are executives who are rewarded handsomely in firms that are experiencing financial losses, facilities closure and employee dislocations in the form of cuts in pay and benefits and forced terminations. At a time when the public is looking for someone or something to blame, is it correct to cap the current executive compensation in the US? This paper will explore this possibility and its impact on American capitalism, whether such a move would be beneficial or harmful to the economy. Background In the United States, the capitalistic system rewards high risks with high rewards and that executives are paid astronomical amounts for their skills and capabilities. The executive compensation in the US consist the total rewards received by the top-level executives of a corporation. These high-ranking officers include the chief executive officer (CEO), the chief operations officer (COO), the chief financial officer (CFO), as well as the other executives who hold the highest level of management in a firm. The total rewards, meanwhile, is generally consisted of salaries, bonuses, incentive payments, deferred compensation plans, stock options, and the direct provision of goods and services. The stock option for executives could surpass the worth the direct cash payments such as salaries and bonuses. Additional perks may include packages that consist housing, personal staff, transportation and other personal expenses of the top executives, which are normally shouldered by employees. According to Alan Greenspan (2007), the former chairman of the US Federal reserve: A [US] CEO’s compensation has, on average, been tied closely to the market value of his or her firm… CEO compensation at such large US corporations reportedly rose by 10 percent annually between 1993 and 2006, triple the 3.1 percent annual increase of earnings of private-company production or nonsupervisory workers. (p. 426) Several studies have examined the absolute magnitude of compensation internationally and they found that the top executives of US-based companies receive a significantly higher level of absolute compensation (i.e., the actual dollar-worth of the entire pay package) than similarly placed executives in non-US firms. (Kolb, p.2) Needless to say, critics focus on this aspect to argue against the current system and advocate a cap on executive pay packages as a way to ensure more profit and balanced ratio between their pay and those rank and file employees. From here, it is easy to understand that criticism against the American executive compensation system stems mainly from the social dimensions of the issue – that it is unethical for corporate executives to amass large amount of money when the average employee receives less. So far, there is no empirical evidence that link the executive pay as the reason behind the financial losses of American business organizations. Stock Option One important fact stands out of all this debate – that stock option drove the rise in median CEO total compensation. The mainstream American companies have dedicated about 3 to 5 percent of their stocks to option grants in the early 1990s and this was increased to about 12 to 15 percent in 2000. (Delves 2003, p. 3) Stocks are not just part of the corporate strategy to lure the best CEOs in the market as a part of a substantial reward. An important rationale for it is that by purchasing the firm’s stock, companies expect that executives ultimately take the same risks as the owners and therefore are bound to perform with the best of their ability so that their companies would make profit. Indeed, according to Greenspan, a significant factor of the excess in the CEO compensation occurs as a result of a general rise in stock prices, over which the average CEO has no control because a company’s share price, and hence the value of related options, is heavily influenced by economy-wide forces – by changes in interest rates, inflation, and myriad other factors wholly unrelated to the success or failure of a corporate strategy. (p. 426) A problem in regard to this area is that stock options became out of control and out of balance. In attempts to make executives think and act like shareholders – to assure commitment and loyalty – option grants created a different thinking among executives. Instead of thinking and acting like shareholders, executives, wrote Delves, began to think and act like option-holders, with far shorter-term and riskier perspectives than is healthy for most companies. (p. 3) Indeed, there are excesses in the current system of American executive compensation. But this does not mean the current system is wrong - the trend does not indicate that it is wrong or that it is moving in the wrong direction. The executive compensation has been one of the strengths of the success of American capitalism and that we have seen in the timeline of the contemporary American economy that it works. The relatively broad-based ownership of American corporations began in the first half of the nineteenth century when Eastern railroads began selling stock in order to finance construction. (Foulkes, p. 31) Although stock had little value when it was first issued, it became a symbol of participation in one of the country’s great enterprises. The railroad’s method of raising capital was widely imitated, providing the foundation of today’s broad ownership. The railroads, America’s first modern enterprise was responsible for the creation of large group of managers and for the development of business principles that still govern American business and that form the cornerstone of the American executive compensation system. Previously, the system has been correct and, it is only during these recent and specific financial debacles when financial troubles as a consequence of executive pay became apparent. An important question that must be resolved is whether top executives of American corporations deserve the compensation that they receive. Most Americans believe that top officers of US companies receive too much compensation. This was reflected in the Business Week-Harris poll wherein it was found that people believe that no executive is worth millions of dollars in annual salary and stock options. (Peterson and Ferrell 2004, p. 72) When all the populist sentiment has gone, however, the reality is different. The executives of a corporation control the deployment of vast resources in the form of the corporation’s financial value, the work of thousands of employees as well as the utilization of land and natural resources to which the firm has access. Now, these executives must make important decisions that have significant impact socially. When an executive commits the corporations that he is working for in wrong investments, he could waste billions of dollars of wealth, take away the means of living of thousands of employees and, worse, drive the company into bankruptcy. From the other end of this argument, correct decisions can yield dramatic results. For instance, IBM’s decision to create the IBM PC in 1981 has launched an industry that have revolutionized the way work is done around the world while in the process creating a number of other related industries and fields that required firms that catapulted some of the greatest individual fortunes the world has ever seen. (Kolb, p. 3) Indeed, a gifted executive who is able to make the right decisions could provide society with immense contributions dwarfing even the most lavish executive pay package. If one, therefore, would be asked if an individual should be paid such very high remuneration package in exchange for his talent and skills that are so socially beneficial, clearly the answer would be yes. There are critics who argue that the stock options and the high reward for CEOs do not usually reflect on performance. However, the amount of executive compensation involved for American companies is so huge that owners and stakeholders of an organization are empowered to safeguard their investments and ensure that executive compensation is directly linked to strong company performance. As a matter of fact, CEOs can be easily monitored, evaluated, and dismissed by their board members. This paper argues that it is here wherein problem begins and could be solved. In addition, the executives hired by large corporations that are given high salary packages get their positions because they have demonstrated that they are more capable than other workers. As McKenzie and Lee (1998) observed, “Scarce talents of the most capable managers are economized by assigning them to positions at or near the top of the largest firms, where their ability is magnified to greater effect by spreading it over longer chains-of-command and larger scales of operations.” (p. 164) This is what sustains high average earnings of top-level executives in large firms and also implies that firm size and executive pay should be positively related. What is worse is that we are in an era wherein top executives are willing to move to other firms which offer higher salaries, more lucrative stock options, bonuses and other benefits, therefore, justifying this kind of thinking. The firm seeks the best manager it could find. Hence, both sides of the bargain, the corporation and executive, wrote Kolb, merely exercise their basic freedoms as economic actors in a free market and reach an agreement on that basis. (p. 4) Check and Balance Regulation for executive compensation – the current favorite alternative of critics – is a sound solution for the problem but this is in the short term. Capping the executive remuneration package is tantamount to limiting the rewards for excellence, good work, productivity and incentives for superior performance. This goes against the American culture of boldness and innovation which have so successfully propelled the American industries to soaring heights. If the government and society punishes the rewards of those who take great risks, then fewer risks will be taken and innovation will be reduced or stagnated. An alternative solution for this, particularly in consideration of more permanent, effective and long-term system that would be applicable and conducive to American capitalism rests on the CEO-stakeholder relationship. One should remember that the stakeholders – the board of directors have the power to monitor, check and control the performance of the top executives and see whether these are directly linked to how much an executive is being paid. It is here wherein salaries are pegged, adjusted and negotiated and therefore, it is also here wherein changes and reforms could be made. As previously mentioned by this paper, even proponents of the current executive payment schemes admit that there are excesses. There are executives who are paid exorbitant amounts but have successfully driven their organizations bankrupt because of bad judgments. But this could be addressed by a more stringent pooling of executives and not government intervention. The stakeholders of an organization have the power to enforce a system of checks and balances that is pivotal in ensuring a focus on multiple perspectives and constituencies as well as on proper distribution of resources, power and decision authority; as well as the responsibility for making changes and setting direction. This future alternative is promising for American companies as critics who focus their criticisms on social grounds could pressure business organizations to be more ethical in setting up their system of executive compensation. References Delves, D. (2003). Stock options and the new rules of corporate accountability: measuring, managing, and rewarding executive performance. McGraw-Hill Professional. Foulkes, F. (1991). Executive compensation: a strategic guide for the 1990s. Harvard Business Press. Greenspan, A. (2007). The age of turbulence: adventures in a new world. Penguin Group. Kolb, R. (2006). The ethics of executive compensation. Wiley-Blackwell. McKenzie, R. and Lee, D. (1998). Managing through incentives: how to develop a more collaborative, productive, and profitable organization. Oxford University Press. Peterson, R. and Ferrell, O.C. (2004). Business ethics: new challenges for business schools and corporate leaders. M.E. Sharpe. Read More