Executive pay is one of the debates and controversial issues in management because of diverse principles and compensation schemes applied to executives and CEOs. There are two opposite positions about this problem: some people suppose that executives are overpaid while other employees receive low salaries for their work; on the other hand, critics admit that CEOs’ performance and managerial skills allow companies to perform and increase their revenues (Balsam, 2002).
Executive pay systems in many US companies have evolved very little in the past fifty years. In the early postwar period, personnel practices moved away from individual appraisals and toward attaching pay to the job, using formal job evaluation techniques, rather than to the worker. In the late 1970s and early 1980s, the importance of job evaluations continued to grow, as they were a central issue in the comparable-worth or pay-equity controversies (Balsam, 2002). Profit-sharing and other gain-sharing plans were widely touted in the 1980s and have grown in some companies. But the proportion of current pay that is based upon such variable elements remains extremely small, averaging under 5 percent.
In general, pay for performance is considered a means of achieving equity through adjusting the individual’s pay to his contributions. In executive pay, attention concentrates on those means that can serve for evaluating these contributions, a variety of measures focusing on inputs such as seniority, education, skill level, or his outputs and performances (Balsam, 2002). Researchers express doubts about the ability of external and internal pay comparability, job evaluation, and pay for performance to approximate pay policy to the proclaimed goal of achieving a measure of justice in pay. These may be useful tools in many respects but their real usefulness regarding pay equity is doubtful for several reasons.
Regarding executive pay comparisons, it is observed that in actual practice wage comparisons are, in essence, a tool for preserving customary wage relationships (Balsam, 2002). Moreover, it is widely recognized that to make wage comparisons an effective tool in a pay policy aiming at pay fairness, much factual information is needed on the comparison referents used by employees, which employing organizations. Social comparison theory suggests that
CEO compensation is based on “opinions, attitudes, abilities, and self-perceptions. When making comparisons, individuals usually use others for comparison who are seen as slightly more skilled or higher paid than themselves. Thus, an executive making self-evaluation comparisons will compare to other CEOs of recognized skill and expertise, and whose recognized value (compensation) is slightly better than their own” (Mallette et al 1995, p. 253).
The belief that comparable wages and job evaluation and pay for performance can bring the employing organization somewhat closer to the target of pay fairness rests on the assumption of an exchange between the organization and the CEO in which the latter is paid for his contributions to the former. It is further assumed that equity can be achieved on the one hand through matching the value of contributions with an appropriate wage (e.g., job evaluation and performance and productivity appraisal) and on the other through internal and external comparability, meaning that the employee is not deprived relative to comparable others inside and outside the employing organization. Indeed, comparability is another measure of worth since it reflects the employee’s alternative value or what he could have received in a similar job (Balsam, 2002).
The main types of pay schemes are stock options, restricted stock, and tax issues. Compensation systems and wage structures, which provide incentives and construct income differences among workers, constitute essential elements of any employment system and economy. If they are to function well, pay systems must be coherently integrated with the other elements of the employment system. Regular workers in large and medium-sized companies experience increased earnings as they age and gain experience with seniority (Balsam, 2002).
They constitute a primary labor market segment. The career pattern is weaker and pay is lower in the secondary labor market segment, which comprises small companies, part-time and temporary workers, and family businesses. The employment and training institutions do generate continuous productivity and earnings growth among a broader proportion of workers and over longer proportions of their careers than is the case in the United States. As a result, institutions generate higher economic growth with fewer earnings inequality among their workforce.
In terms of Managerial Hegemony Theory: “boards are expected to approve lucrative compensation plans for CEOs rather than actively monitor and control CEO behavior through these plans. This viewpoint does not suggest that CEOs never warrant generous compensation, but only that boards tend to approve those packages without evidence of their merits” (Mallette et al 1995, p, 253). For example, a job that involves high costs in responsibility accepted, skill expected, anxiety borne, and peace of mind forgone is an important job that entails great reward potential.
High costs of this kind are congruent with high investments and rewards. On the other hand, a job that involves high costs in “mere dirt or monotonous drudgery” is usually not important and does not entail great reward potential since the capacity to perform it is probably not rare. High costs of this kind are congruent with low investments and rewards. Indeed this later work of the status value theorists extends the scope of the theory to include situations where reward ranks are positively associated with ability and performance criteria and clarifies how multiple inputs or investments, and hence multiple referential structures, operate (Balsam, 2002).
It shows how statuses become relevant to differential abilities or task outcomes and how they combine to determine positions in the prestige hierarchy. It also provides clearer insight into the reverse process whereby inferences are made about abilities and performances from reward levels achieved by individuals. All the major theories reviewed propose that social comparisons constitute a major and essential ingredient in the fairness evaluation of rewards. All of them have been criticized for failing to elaborate on this issue and for leaving many open questions. A leading question here is if reward evaluations always involve a process of comparison with others (Balsam, 2002).
A well-structured compensation system provides rewards that simultaneously motivate effort and productivity growth over time and satisfy norms of fairness. Effort and productivity growth can be motivated by career-structured incentives, structured fairness, and reciprocity between employer and workers, or a combination of these two. While career incentives and concepts of fairness for CEOs are seen as competitive with each other in some countries like the United States, they are seen as complementary in Japan.
Fairness is enhanced when rewards are connected to performance uniformly for all individuals. Insofar as pay or promotion are connected to evaluations, fairness requires that supervisor ratings of employees are done carefully, without favoritism or gross differences between supervisors in rating criteria. Critics admit that Balsam (2002) perceived unfairness and favoritism by supervisors constituted one of the most frequent complaints of U.S. workers, at levels far exceeding those voiced among Japanese workers. These differentials are partly cultural in origin, in the sense that social norms make workers feel more entitled to voice complaints about fairness than is the case among workers (Balsam, 2002).
Fairness on executive compensation is also enhanced when pay differences among jobs are related to widely accepted social norms. The differentials that are most often recognized as legitimate by both workers and management involve differences in skill or training, responsibility, effort, working conditions, and schedules. In Japan, seniority also provides a legitimate source of pay differentials for the same job as well as for promotions. An interesting question concerns the elasticity of effort concerning pay.
High compensation rates for CEOs are explained by unique skills and talents among these employees. In bringing about and fostering the required committed synergy, quickly, the leader takes on the combined roles of enthuser, choreographer, and conductor (Balsam, 2002). As conditions stabilize and the group acquires functional maturity through the experience of working together, the quality of its teamwork is likely to become self-generative and self-sustaining.
In the initial stages of a crisis or major change, however, it is leadership that provides context, perspective, and hope of a solution, through a perceived combination of personal competence, confidence, and ‘clout’ The roles of CEOs are complementary and serve to fulfill differing, but related functions in bringing about the development and success of an enterprise, project, department, or work team (Ellig, 2007).
The above is essentially growth – not merely survival – behaviors and, therefore, are more characteristic of successful, high-achieving work teams. Survival behavior, by contrast, is much more concerned with boundary, goal, and structure preservation, not expansion, transformation, and development (Balsam, 2002). Teams in a state of transformation and growth cut through and extend their boundaries and show high confidence both in integrating newcomers and in spawning new groups, or sub-groups, without losing their core values, and sense of identity. What is more, high achieving groups, generally, demonstrate both greater capacity and increased willingness to pass on their learning in an intelligible form to others (Balsam, 2002).
For CEOs, the compensation system can include both individual and group elements. The group elements can take the form of team-based or company-based elements of compensation (gain sharing and profit sharing). The modern patterns conform to the “pay politics” model of Lazear (1989 cited Ellig 2007), in which pay is more compressed for highly opportunistic workers to reduce rewards to noncooperative behavior among workers and to elicit cooperation in teamwork. However, the assumption made by Lazear that performance pay is based on individual outcomes is not observed in Japan, where individual performance appraisal includes an evaluation of the worker’s contributions to the team and co-workers. In this way, performance-based pay, individual effort, and team effort are made compatible and reinforcing.
Although most critics claim to base their pay systems upon individual performance, in most large companies appraisals for non-managerial or nonprofessional workers are not important (Ellig, 2007). In unionized companies, CEOs’ appraisals are infrequent, are often only cursorily performed, and usually focus only on whether each worker is meeting minimum production and attendance standards. Seniority is more important than merit for pay increases, and pay increments are relatively small. In nonunionized companies, individual appraisals play a larger role in determining pay increases, although they do so less often than personnel managers claim, and again with small differentials.
Appraisal systems are limited by the difficulty of measuring individual contributions objectively. Managers typically rely upon individual supervisors to make subjective judgments about each worker, leading often to excess leniency, low reliability, charges of favoritism, or feelings of resentment (with self-appraisals generally higher) (Ellig, 2007). Although such problems can be reduced by careful training of supervisors, special training to conduct appraisals is not very common (Balsam, 2002).
A pay system that rewards longer tenure with the firm supports the practice of employment security by inducing workers to stay and by encouraging management to train workers as they gain experience and move up the pay tables. Following Ellig (2007) 50% of the Fortune 500 CEO pay is cash pay and bonuses. The approximate salary of a CEO is $1-$3 million, while bonuses can reach $10 million – $15 million.
A pay system that rewards the acquisition of knowledge and skills motivates employees to acquire additional training and to be involved in work tasks using their skills. A pay system that rewards individual performance encourages employees to be active in workplace improvements and induces managers to develop efficient and equitable appraisal systems. These considerations suggest that an ideal compensation system would contain all three of these pay elements (Berger & Berger 1999). Nonetheless, the payment systems at the companies in the United States generally do not incorporate all three elements, and at many companies pay continues to be structured in a traditional manner (Balsam, 2002).
The pay of CEOs relative to that of production workers provides an even greater contrast between Japan and the United States. While production worker pay data are relatively accurate, in both countries the estimates of CEO compensation can vary substantially. Estimates of CEO pay for the United States are somewhat more precise, but it is clear that CEOs are highly paid. In 1999, the ratio of the pay for the CEOs of the largest 200 companies to that of the average production worker was about 40 to 1.
This ratio was already much higher than the comparable figure for Japan (Balsam, 2002). These CEO compensation comparisons may be biased because they omit important perks received by Japanese executives, such as access to expensive golf club memberships and meals inexpensive restaurants (Berger & Berger 1999). Although the data indeed exclude noncash executive benefits, such as corporate club memberships, these perks are common in both Japan and the United States, though perhaps at very different relative prices. More importantly, the data do include bonuses, golden parachutes, and stock options, which are rare in Japan but extremely common and generous in the United States and of far greater monetary value than noncash perks.
In sum, top managers and CEOs have a more performance-oriented pay system. Evaluations are more frequent, more formal, and affect promotion and pay increases. In many companies, some managers may be able to advance. rapidly, and it is not uncommon for lower-level managers to be supervised by much younger and less experienced fast-trackers. Different compensation systems and high rates established for executives suggest that companies fight for top talents proposing top managers high compensation and rewards.
References
- Balsam, S. (2002). An Introduction to Executive Compensation. Academic Press; 1st edition.
- Berger, L. A., Berger, D. R. (1999). The Compensation Handbook. McGraw-Hill; 4 edition.
- Bebchuk, L., Fried, J. (2004). Pay without Performance: The Unfulfilled Promise of Executive Compensation. Harvard University Press.
- Ellig, B. R. (2007). The Complete Guide to Executive Compensation. McGraw-Hill; 2 edition.
- Mallette, P., Middlemist, D., Hopkins, W. E. (1995). Social, Political and Economic Determinants of Chief Executive Compensation. Journal of Managerial Issues, 7 (3), 253.