Abstract
Under normal circumstances, the assumption is that a highly paid executive is highly motivated to produce better economic results for the company. But this does not seem to work with the US CEOs. There are two reasons why high CEO compensation may not work better for the company; there will be a constant comparison by the employees of their salaries with that of the CEOs to consider whether the CEO is worth the compensation being paid to him/her. This might lead to resentment among workers towards the top management. The second reason is that the CEO might be working for the company only because of the higher compensation. This may not be good for the company as it is better to employ a CEO who feels committed to the organization instead of one who just stays for the compensation and perquisites offered by the company (Alexander Kjerulf). This paper makes a review of the CEO salary payments in the US.
Introduction
The executive compensation is a matter of concern to the shareholders of a company since the cash outflows from the company on the compensation for the CEO and other executives are phenomenally high. According to a study conducted by the economists Lucian Bebchuk and Yaniv Grinstein, a whopping amount of $ three hundred and fifty billion was paid as compensation to the top five executives during the period 1993 and 2003 in the 1500 companies examined by them. No doubt, that the CEOs need to be taken care of well, to motivate them to perform. However, such a high level of pay can be justified only if it leads to better performance. But it appears that most of the CEOs are paid huge sums as compensation even though their contribution to the success of the company does not entail them for such fabulous salaries. The most important point in the issue of CEO compensation is that from the shareholders’ perspective the higher CEO compensation is not just overpayments but is highly destructive of the profitability of the corporations. It has been out of a recent study by economists at Rutgers and Penn State that the shares of the company whose CEO is paid more than his/her peers are more likely to underperform in the stock market (James Surowiecki, 2006). There are some ways in which excessive pay packages can do damage to companies.
Justification for the Compensation
There are different viewpoints on the high CEO compensation. While some argue that such high levels of compensation are sheer waste of corporate resource, some are of the view that the performance of the CEOs are in no way related to the pay packets they receive. According to John Mariotti, President of the Enterprise Group the demand for CEOs with real talents increases as the businesses are becoming more complex. This makes the CEOs command greater compensations. He further adds that such outstanding performers are normally motivated only by challenges and the level and amount of compensation has very little to do in the matter of motivating them (John Reh) The higher compensation may be the result of the fact that the CEO compensation is usually decided by the compensation committees which normally comprise of other chief executives. Graef Crystal of San Francisco Business Times is of the view that the pay package of the CEOs does not affect the future performance of the CEO and irrespective of the success or failure of a company the CEOs perform in the same way.
CEOs Deserve High Compensation
The viewpoint here is that the dishonest CEOs as in the case of Enron or Worldcom – where corporate scandals not only brought the respective companies down but also shook the investor confidence to a great extent – are rarest of the kind. The position and contribution of all the CEOs cannot be equated to the CEOs of ill-fated companies. For instance, Jack Welch when appointed the CEO of General Electric (GE) in the year 1981 the value of the company was a mere $ 14 billion. With his relentless efforts and through a process of hiring and firing and buying and selling and adopting different management techniques Jack Welch made a turnaround of the company to reach a stage of $ 500 billion worth company.
If the compensation for his hard work is to be calculated based on a percentage of the value-added to the company it would run into a few billion instead of a few hundred million dollars paid to him as compensation. Another example may be found in Jim Kilts who took over as CEO of Gillette Co in the year 2001. At the time Jim Kilt took up the assignment the share value of Gillette was very low and he could make the company a huge success that it is being acquired by Proctor & Gamble at an estimated value of $ 11.3 billion with an addition of $ 5.7 billion after the announcement of the acquisition. Considering the buyout value of $ 57 billion for Gillette offered by Proctor & Gamble the compensation of $ 153 million to Jim Kilts is reasonably justified (Walter Williams, 2005).
Contrarian View of CEO Compensation
Economists Xavier Gabaix and Augustin Landier suggest that the higher compensations for the CEOs in the US companies are the result of the increase in the stock market valuations and the increase represents the competitive pressure rather than the exploitation of the shareholders. They argue that the economic value of the corporation increases due to better executive decisions by the CEOs and when the number of chief executives is less than the large companies who require their talents it is quite but natural that the competition will push up the value for the available chief executives. They further add that the CEOs in the US are paid high as compared to those in other countries. However, this argument of comparison with the pay in other countries is countered by stating that the productivity growth in the US has by far been much better than in the other countries which means that the CEOs are doing something different in the US for which they deserve the higher compensation (Tyler Cowen, 2006)
“The usual explanation given by economists for the positive relationship between compensation and firm size is that the largest companies attract the best management” (Becker-Posner, 2006). This argument implies that it may be considered socially efficient to have the best CEOs run larger companies so that a larger amount of labor and capital is put at their disposal which when handled efficiently would produce tremendous results.
Adverse Effect on Corporations
There are different adverse effects that a high CEO compensation may have on the growth and future of the companies. For instance, the ‘Golden Parachutes’ – schemes designed to guarantee the CEOs handsome payoffs when the companies are acquired by others – often encourage the CEOs to sell out the companies even when the companies are doing better and would do well to remain independent on their own. There may be instances where the highly paid CEOs are likely to make acquisitions of other companies in return for huge financial rewards even though such acquisitions do not have any incentives whatsoever to increase the corporate values of the parent company. Instead, such acquisitions only destroy the corporate values of the companies for which the CEOs work (James Surowiecki, 2006). The other probable scenario where a company may lose its value is the frauds and criminal activities in which the high-paid CEOs may engage themselves to gain monetary advantages and personal financial gains.
CEO Overcompensation and Investors
Although it may not be possible to treat every compensation package as a waste of money, more and more large investors look into excessive CEO compensation as an indicator of corporate performance. They suspect something is wrong with the company if it pays an exorbitant CEO salary. With a high CEO compensation, the investors take it as a sign that the board of directors succumbs to the whims of the CEO instead of supervising and monitoring his performance (James Surowiecki, 2006). Despite the ineffectiveness of the new SEC rules to solve the issues relating to weak boards or control on the CEO performance, such rules help facilitate the investors to figure out the number of cash flows on account of CEO and other executive compensation and make informed decisions on their purchases of stocks of different companies.
CEO Compensation and Corporate Governance
One argument in favor of high CEO pay is that private companies do well by paying high compensation to the CEOs than the public companies. The argument goes further in stating that the CEOs do not control the Boards of public companies and hence they are not being offered higher compensation that equals their performance by the Boards of public companies. This gives rise to the point that US CEOs, Boards, and corporate governance are subject to the interactive market forces which decide the CEO compensation levels also (Steven Kaplan, 2007).
Still, there is the question of CEO turnover in the companies that need to be addressed. The CEO turnover rate is 14.9 percent from the year 1992 to 2005 implying that the average tenure of a CEO is less than 7 years (Steven N. Kaplan and Bernadette A Minton, 2006). Another alternative viewpoint is that the CEOs are also subjected to huge losses resulting from bad luck. The bad luck in turn takes the form of dismissal or resignation of the respective CEOs. Therefore it is stated that the CEO turnover to some extent is dependent upon the bad luck for them. However, Gerald & Todd (2004) are of the view that CEO turnover has no statistically significant association with luck. Hence they opine that the dismissal or resignation of the CEO cannot be considered as the punishment for bad luck.
Conclusion
From the foregoing and a review of the available literature, it appears that no doubt that the CEOs in the US are paid a lot more than what they have been receiving as compensation a few years before. The higher compensation levels and the dubious performance of some of the CEOs of US Corporations have led to the controversy that the average CEO pay is excessive and the opinion is purely based on the actions of few dishonest, manipulative top executives and the boards which are ineffective. The press and academics appear to have omitted great contributions by many of the CEOs to the enviable corporate growth of the United States which more than justifies their compensation packages though appear to be high on relative terms.
References
Alexander Kjerulf ‘High CEO pay – Low Performance’. Web.
Becker-Posner (2006) ‘Are CEOs Overpaid?’. Web.
Gerald T. Garvey & Todd T. Milbourn (2004) ‘Asymmetric Benchmarking in Compensation: Executives are rewarded for Good Luck But not Penalized for Bad Luck’. Web.
James Surowiecki (2006) ‘Overcompensating’ The New Yorker. Web.
John Reh ‘CEOs Are Overpaid’ About.com: Management. Web.
Steven Kaplan (2007) ‘Are CEOs of US Public Companies Really Overpaid?’ The Harvard Law School Corporate Governance Blog. Web.
Steven N. Kaplan and Bernadette A Minton, (2006) ‘How has CEO Turnover Changed?
Increasingly Performance Sensitive Boards and Increasingly Uneasy CEOs’. Web.
Tyler Cowen ‘A Contrarian Look at Whether US Chief Executive Are Overpaid’ The New York Times. Web.
Walter Williams (2005) ‘Are CEOs Overpaid?’ Capitalism Magazine. Web.