Examining Present Day CEO Compensation

Subject: Employee Management
Pages: 9
Words: 2551
Reading time:
10 min
Study level: PhD

Introduction

Massive executive compensation packages are often viewed with disdain by the “everyday working man” within today’s factories, call centers and corporate offices. A worker looks at their salary that barely allows them to live paycheck to paycheck while, on the other hand, the CEO of their company is paid millions of dollars and gets to live a life of luxury. Resentment obviously develops, resulting in many workers questioning the sheer difference in paychecks when they work hard for the company and get a pittance in comparison to the compensation given to the CEO.

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This is the general consensus that the Shalev, Zhang and Zhang (2013) study determined when it examined the point of view of workers when it came to the present day wage gap scenario. Simply put, workers perceive the sheer difference in compensation as being unfair given the amount of work they put into the company (Shalev, Zhang and Zhang, 2013). However, studies such as those by Black, Dikolli and Dyreng (2014) stated that this point of view of workers is based on a considerable level of solipsism and irrational exuberance.

Black et al. explained that the resentment behind the wage gap scenario has hints of solipsism since the resentment of the workers originates from the thought process of “all else is equal” which ascribes to the notion that the wage gap is unfair based on the amount of work they also put into their jobs (Black, Dikolli and Dyreng, 2014). This thought process neglects to take into consideration the differences in skill, profession and experience between them and the CEO of the company.

Black et al. stated that compensation is normally based on what a person does for the company and their general impact on the company’s operations. The greater the impact and presence of the individual within the company, the higher their corresponding wage. This helps to explain why there is a significant gap between workers and CEOs; however, ordinary employees often fail to take this into consideration and label the gap as simply being “unfair”. Another way in which such a thought process originates from and spreads is based on the notion of irrational exuberance which is a way in which people base their actions on the behavior of other people.

In this scenario, low wage workers base their perception regarding the “unfairness” of the wage gap from the opinions of other individuals. This creates a cascading social phenomenon wherein an increasingly large number of people state that the current gap is “unfair” without really understanding the factors that contributed towards a CEO receiving such a high wage in the first place. This is not to say though that perspective of ordinary workers is completely erroneous. Recent statistics via the Seo, Gamache, Devers and Carpenter (2015) study show that CEO compensation in the U.S. reaches 350 times that of an ordinary worker. This is a massive gap when compared to other industrialized companies in Europe such as Germany where CEO pay rates are only 148 times that of an ordinary worker (Seo, Gamache, Devers and Carpenter, 2015).

When examining both sides of the argument, the study of Cao and Wang (2013), which examined pay grades and experience, showed that compensation is often based on the experience, amount of work and the value of the position to the company. Based on this perspective, it can be suggested that the high rates of CEO compensation are actually justified given the amount of experience, work and value of the position to the company (Cao and Wang, 2013).

On one side of the argument is the concept of “unfairness” based on the perceived notion that the compensation of CEOs should not be as large as it currently is. However, on the other side of the argument is the concept of “value” wherein the skills, expertise, experience and vision that CEOs bring to the table makes them a valuable asset that can make or break a company’s future. It is based on these contending perspectives that this paper will examine the justification of CEO compensation, the value of CEOs to companies, the philosophical debates regarding compensation and how all these aspects factor into present day CEO compensation packages.

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The main question that this paper will attempt to answer is if CEOs merit their current salaries based on how they impact company operations or if reductions are necessary. This paper theorizes that present day CEO compensation packages are actually justifiable provided that CEOs show that they actually match the value being ascribed to them.

Understanding the Origin of High CEO Compensation

One way of understanding the origin of absurdly high rates of CEO compensation is via the study of Abernethy, Yu, and Bo (2015) that examined the increase starting from the 1950s onward. Abernethy et al. stated that the 1950s started the trend in high compensatory practices that culminated in the 1980s and really took off during the latter half of the 1990s. The basis behind this was the concept that CEOs were “agents of transformation” for companies and that they were essential for a company’s success.

This was due to their perceived capability to enact company wide changes that would enable a corporation to stay ahead of its competition via innovative strategies, better product and service development as well as more streamlined operations, all of which supposedly originated from the office of the CEO (Abernethy, Yu, and Bo 2015).

Evidence of the “transformational” capabilities of CEOs was noted in the case of Larry Elison, Steve Jobs, Bill Gates, Warren Buffet and dozens of other examples that showcased the importance of CEOs as having the necessary “vision” and capability in order to enable a company to become successful. It was due to the popularity of this notion that from the 1980s onward companies began offering increasingly higher compensation packages in order to retain CEOs or to bring a new CEO into the company after the previous one retired. Such a strategy is in line with extrinsic methods of motivation wherein an individual is retained or brought into to the company on the basis of significant financial compensation.

In the case of CEOs, the magnitude of compensation is much larger as compared to that of an ordinary worker due to their perceived higher value and how they impact company operations in a “grander” scale. Aside from this, the late 1980s onward began what is known as the “war for talents” as described by Abernethy et al. This resulted in corporations placing a “premium price” on talented individuals, particularly CEOs who they believed were absolutely necessary in order to take the company to the next level.

Such a concept lead to the creation of what is known as the “transformational CEO” whose capabilities, talent and vision enables a company to develop the necessary strategies in order to become more competitive in their respective industries. All of these aspects have culminated in the present where acquiring and retaining talented CEOs through high compensation packages is perceived as being a “necessary evil” in today’s hyper competitive system of interconnected markets.

When CEO Compensation Fails

So far it has been shown that present day levels of CEO compensations are justified based on the impact of CEOs on the success of a company; however, what happens if the output of the CEO does not justify the amount that they are paid? For instance, Ed Zander (former CEO of the now defunct Motorola Company) attempted to “enhance” the company’s performance by increasing internal competitiveness among the different departments within it. This decision was credited as being one of the reasons behind the dissolution of the company due internal conflicts reaching such a scale that new developments simply were not being created or properly implemented.

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Despite his actions, Zander was still compensated $17 million a year till he was ousted from his position. Another clear example is that of Fannie Mae CEO Franklin Raines who was paid $20 million a year until the end of 2003. His tenure at the company resulted in intentionally misrepresented earnings, excessive bonuses paid to the upper management of the company as well as anomalous accounting errors that resulted in the company requiring a bailout of $200 billion from taxpayers. This was approved since the company was considered as an “essential and integral” aspect of the American financing system (Darrough, Guler and Wang, 2014).

There are several dozen more examples of CEOs causing more harm than good and this shows that they are not infallible and can often make mistakes that can result in thousands of people losing their jobs. However, the main problem with this situation is not the fact that they make mistakes, it is the fact that despite being responsible for severely damaging the operations of the company they were still compensated for it.

Darrough, Guler and Wang (2014) explained that the reason this occurs is due to contractual obligations on the part of the company to pay their CEOs the amount of compensation that they were promised. When taking this into consideration, it is obvious that this type of practice should be stopped since high compensation should be based on positive performance and not negative ramifications.

Philosophical Notions on Compensation

Two of the current philosophical notions that are connected to compensation is that of poiesis (described as “work” that is done in order to create something useful to the community) and praxis (considered to be “work” that is done for its own sake rather than contributing to something greater) which were originally developed by Aristotle. Under the principle of poiesis, its “value” is based on its outcome. This means that the notion of poiesis is based on how beneficial a particular outcome of “work” is to the general community. Praxis, on the other end of the spectrum, is considered to be worthwhile if its outcome goes well.

Examples of praxis can be seen in the many different artistic and creative pursuits that are seen today wherein the creative output is not necessarily immediately beneficial to the community but its relevance, based on its aesthetic appeal, does create value and thereby merits a certain level of compensation. However, praxis is not really considered as “work” based on present day standards; instead, it is poiesis which is concerned with the outcome that is the more dominant concept today.

This is due to the fact that the concept of “work” at the present is considered worth doing based on its intended outcome. Work as a philosophical concept under this perspective is thus “done” for the sake of something else and is not done for the sake of doing it or due to a sudden personal whimsical desire to do a specific task (no one goes to work in a factory simply because they feel like doing it). It is more accurate to assume that people seek gainful employment in order to contribute to something as well as gain something from it. The “gain”, in this case, comes in the form of monetary compensation which the workers utilize in order to lead lives outside of the company and take care of basic necessities (Adhikari, Bulmash, Krolikowski and Sah, 2015).

However, the “value” attached to work is not limited to its physical compensation; rather, it also extends to psychological benefits as well wherein the German philosopher Hegel stated that people tend to crave public recognition for their skills which “work” tends to provide.

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It is based on this that ordinary workers connect the “value of work” to the monetary compensation and public recognition they receive. However, another way of interpreting the poiesis perspective is that the “gain” received by a particular individual is based on their contribution towards the end result that is being pursued. While the concept of an “end result” is rather vague when applied to companies since they focus on continuous operations, one way of interpreting this is to consider the end result as the amount of revenue generated by a company within a given year.

As such, the “value” of workers can thus be based on how well they have contributed towards the end revenue of the company. Given the fact that CEOs determine the strategies to be utilized, how the company should operate and what specific type of product lineup they should produce, it can be assumed that they can have a significant impact on the revenues generated by the company, more than what an average worker does during their lifetime at the company. Taking all these factors into consideration, CEOs deserve their high levels of compensation given their impact and presence in multiple aspects of a company’s operations and their contribution towards the poiesis of the company.

Recommendation

After going through all the arguments that have been present so far, this paper suggests that the problem is not necessarily the huge salaries of CEOs; rather, it is the fact that present day wages have failed to keep pace with inflation as well as the fact that CEO compensation should be based on proven performance. The O’Connell and O’Sullivan (2014) study which delved into worker compensation showed that after the 1950s, worker compensation has not been properly connected to inflation. Instead, current trends in employee compensation are based on performance, trends in employee compensation in particular job sectors and the minimum wage that is present in various states (O’Connell and O’Sullivan, 2014).

This means that, for low level employees, their level of compensation is not based on what the company perceives as a “living wage” but rather one that follows industry standards and is within the “legal range” set by the state. The inherent problem though is that estimates that set minimum wage and industry standards for compensation are often “late” by 5 to 10 years depending on the last time a proper consensus was done that examined current prices and compared them to what workers are earning. Chen (2015) even suggested that one of the reasons why there is so much outrage over the current CEO wage gap is simply because workers feel that their wages are barely allowing them to survive.

This means that if companies start paying their workers what can be considered as a “decent” living wage within their respective states, it is likely that the sheer amount of vehemence over the current wage gap should decrease (Chen, 2015). On the other end of the spectrum, the section on incompetent CEO actions shows that compensation should be based on performance and not merely presence. CEOs should prove that they deserve the compensation that they are being given so that workers will not question why the CEO is paid so much. Examples of this can be seen in the case of Arthur T. Demoulas, CEO of Market Basket, where in 2014 he was ousted as president by the board. The workers of the company rallied to bring him back due to how well he treated them and how much they loved him as the CEO.

Conclusion

Overall, it can be stated that present day CEO compensation packages are actually justifiable provided that CEOs show that they actually match the value being ascribed to them. This paper has shown is that what is needed is to examine how companies pay their workers and how the performance of the CEO is measured and an appropriate level of pay given.

Reference List

Abernethy, M. A., Yu, K., & Bo, Q. (2015). The Influence of CEO Power on Compensation Contract Design. Accounting Review, 90(4), 1265-1306.

Adhikari, H. P., Bulmash, S. B., Krolikowski, M. W., & Sah, N. B. (2015). Dynamics of CEO compensation: Old is gold. Quarterly Review Of Economics & Finance, 57(2), 191-206.

Black, D. E., Dikolli, S. S., & Dyreng, S. D. (2014). CEO Pay-for-Complexity and the Risk of Managerial Diversion from Multinational Diversification. Contemporary Accounting Research, 31(1), 103-135

Cao, M., & Wang, R. (2013). Optimal CEO Compensation with Search: Theory and Empirical Evidence. Journal Of Finance, 68(5), 2001-2058.

Chen, G. (2015). Initial compensation of new CEOs hired in turnaround situations. Strategic Management Journal, 36(12), 1895-1917.

Darrough, M. N., Guler, L., & Wang, P. (2014). Goodwill Impairment Losses and CEO Compensation. Journal Of Accounting, Auditing & Finance, 29(4), 435-463.

O’Connell, V., & O’Sullivan, D. (2014). The influence of lead indicator strength on the use of nonfinancial measures in performance management: Evidence from CEO compensation schemes. Strategic Management Journal, 35(6), 826-844.

Seo, J., Gamache, D. L., Devers, C. E., & Carpenter, M. A. (2015). The role of CEO relative standing in acquisition behavior and CEO pay. Strategic Management Journal, 36(12), 1877-1894.

Shalev, R., Zhang, I. X., & Zhang, Y. (2013). CEO Compensation and Fair Value Accounting: Evidence from Purchase Price Allocation. Journal Of Accounting Research, 51(4), 819-854.