Should Governments Limit CEO Compensation?

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Government regulation is necessary to limit excessive CEO compensation in the UK. To what extent do you agree?  

Introduction

The topic of immoderate executive payment is becoming controversial in the business press and the media coverage. Government regulation is a rule or directive made and maintained by the government which controls the operation of a business. A chief executive officer (CEO) is the highest-ranking position in a firm whose principle responsibility is making significant corporate decisions. Executive compensation includes financial and non-financial awards from the company for their service to the organization. It is composed of salary, bonuses, shares on the stock market, benefits, and perquisites. CEO pay in the United Kingdom has inflated considerably within the past decades due to changes in policy, culture and the globalisation effect on the economy. While some in the UK believe that spending a large amount of money on executive payment might have some adverse effects, it is generally accepted that it has more advantages financially, ethically and socially; therefore, it should not be limited by the government.

Financial perspective

From the economic perspective, a serious downside is the firms might get into financial crisis. Executive compensation takes a notable, perhaps most influential, part in financial crisis and recession by emboldening extravagant risk-taking and short-term strategies (Kay, 2009, p. 2). As CEOs earn so much within one year, they do not have to care about how much they lose if the company gets into trouble. The amount of money they possess is extravagant, consequently, they do not mind taking risks. Risks can lead to a huge success; however, it can also result in recession. Greenberg (2010) states that owners of banks and workers claim the benefits if the business goes well and the economy is supportive, but if things go poorly and the economy is unhealthy, community finances the failures. Since the owners and employees of financial companies do not have not have to take full responsibility for their losses, they are more likely to take more risk than others. This grows the number of bank failures, systemic risk and taxpayer costs. While that statement is true in some cases, it can be strongly argued that executive pay increases productivity of the company. According to Herzberg’s two-factor theory, both intrinsic and extrinsic factors are important. However, extrinsic factors are considered to be more fundamental as they are core human needs. Incentives might be fruitful at boosting performance in some circumstances. It, for example, might help people accomplish projects they would not otherwise want to carry out (Delves, 2011, p. 9). Delves (2011, p. 9) also showed that extrinsic rewards are necessary in getting people to do work which is well-defined or involves repetition, or especially tasks they cannot find personal meaning or value in undertaking. Many work for money and enjoy spending it so a combination of monetary remunerations and the intrinsic motivators may be most effective. CEOs can feel motivated when getting paid highly, thus, the productivity of corporates increases.

Ethical perspective on workers

It is almost always stated that immoderate executive remuneration is not ethical for workers. The poverty rate in the UK may decline but the inequality is bigger than ever. According to Sky News (2010), it has been presented in a research that the link between executive high pay and company performance is totally negligible. In the last 10 years, executive pay has risen by 80% in contrast with the return on investment has only increased by 1% (Sky News, 2017). As stated by the TUC analysis of FTSE 100 directors’ pay in 2016, the annual salary for average UK workers equals to just how much Martin Sorrell, the Britain’s highest paid chief executive, earns in less than three quarters of an hour. The company WPP paid Mr. Sorrell £70 million in 2015, which is over 2,500 times the median UK salary (TUC, 2016, p. 2). While millions of UK families have their living standards squeezed, directors’ pay has reached stratospheric levels, as a consequence, those who are at the lower end of the wage scale are unpalatable to hear that bosses are being paid imprudently. If shareholders pay chief executive a lot but pay those at bottom very little then it is actually the taxpayers who end up paying for it. Nevertheless, executive compensation should not be capped as they deserve it. Company shareholders have the right to decide how much should they pay for the CEO. In the past, a chief executive could usually keep the positon for years despite lacklustre results. Today, a CEO who fails to attain achievements is often dismissed in a short period of time. When executives are capable, they can add value to their firms much more than they are being compensated. In big companies, even minor differences in managerial talent can have an enormous impact. Considering the scenario when a company with yearly earnings of $10 billion and has only two finalists in executive search, if one makes just a few more better decisions per year than the other, the firm’s earning might easily be 3 percent, which equals to $30 million, higher than that under the candidate’s management (Frank, 2009, p. 7). The same executive cannot make as much difference at a company with only $10 million in earnings every year (Frank, 2009, p. 7). A gifted executive from one industry, in addition, can also bring about proficient performance in others. Therefore, employees would want to have best leaders in charge of the firms so that they can be globally competitive and succeeding on a global level (Sky News, 2017). For instance, Samsung decided to make smart phones and is now much more successful than SONY. All because of that strategic decision they made. Firms need to have the best talent at the top because the strategic decisions that those CEOs make can have a huge impact not just on whether the firm is profitable or not but on the life and death of the firm. Consequently, businesses where managerial decisions have substantial effects tend to outbid others in recruiting the most skilful executives.

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Social perspective

On the one hand, executive remuneration should be controlled by government regulations as firms can retain more money to spend on corporate social responsibility (CSR), which involves actions the company takes to pay back for the its impacts on the environment and social wellbeing. Businesses often spend a large amount of money for CEO compensation. Figures for annual total remuneration minus pension contributions from FTSE 100 companies have been shown in annual reports at the end of May 2016 (TUC, 2016). Sir Martin Sorrell from WPP ranked first place with almost £70 million in 2015, following by Tony Pidgley from Berkeley Group Holdings PLC and Rakesh Kapoor from Reckitt Benckiser Group PLC at roughly £23 million (TUC, 2016). Hence, reducing executive compensation can help save a lot for CSR spending. Investment of the company into local communities, namely building schools, offering medical services or improving irritation and sanitation equipment, can deduct the detrimental effects their operations may cause. Additionally, a company can invest in environmentally-friendly technologies and have more eco-friendly projects. These might not lead to increased profitability but they pay for the externalities. For today firms, CSR is an essential way to increase competitive advantage, protect and raise brand awareness and build trust among stakeholders such as customers and employees. As a result, regulating executive pay not only help the society but also the company itself. On the other hand, offering a large amount of CEO compensation can help attract top talents at executive level. The competitiveness of the labour market for qualified executives helped enhance their pay packages in past years (Kay, 2009, p. 5). It is believed that a suitable chief executive can add billions of dollars to shareholders but an expert CEO is a scarce commodity most of the time (Kay, 2009, p. 5). CEOs might work elsewhere which offers more financial incentives. Although every company wants a talented chief executive, there are not so many options to choose from. If salaries were capped, candidates would have fewer reasons to seek employment that maximise the use of their talents (Frank, 2009, p. 5). Furthermore, if executive pay were capped and salaries for other jobs was not, many potential managers would choose to become lawyers or hedge fund operators (Frank, 2009, p. 6). The survey conducted by Donatiello, Larcker and Tayan (2017, p. 4) states that almost all (98%) directors are convinced that the CEO job is really challenging and only a small number of executives are capable of leading companies in their industry. It is also estimated only fewer than four executives can meet the requirements to replace and perform at least as well as the current CEOs (Donatiello et al, 2017, p. 4). This concludes that the supply of outstanding CEO talents is becoming more intense than ever (Donatiello et al, 2017, p. 8). Offering more incentives to the executives, hence, is an important strategy to develop the business.

Conclusion

To summarize, the UK governance experts have vigorously discussed the properness of executive remuneration in recent years. While negative effects of not regulating CEO compensation are visible, it is probable that it benefits more than harms, which has been clearly demonstrated from three viewpoints: fiscal, social and ethical. Although excessive compensation paid to chief executives can lead to inequality and financial crisis, they deserve it due to the scarcity of CEO talent and the value they contribute to the company. Wage gap should be focused but not by trying to decrease the earnings of the top because it is a very dangerous and counterproductive way. It is recommended to protect core incentives and minimize irritants.

REFERENCE LIST

  1. Delves, D. (2011, February 16). Is Incentive Compensation a True Motivator? Retrieved May 14, 2018, from https://www.forbes.com/sites/donalddelves/2011/02/16/is-incentive-compensation-a-true-motivator/#7b3d600c7904
  2. Donatiello, N., Larcker, D., & Tayan, B., (2017). CEO talent: A dime a dozen, or worth its weight In gold? European Financial Management. Retrieved 20 February 2018 from: http://onlinelibrary.wiley.com/doi/10.1111/eufm.12158/epdf
  3. Frank, R. H., (2009, January 03). Should Congress Put a Cap on Executive Pay? Retrieved May 2, 2018, from: https://www.nytimes.com/2009/01/04/business/economy/04view.html
  4. Greenberg, M., (2010). Regulation of Executive Compensation in Financial Services. Greenberg Center for Geoeconomic Studies. Retrieved 01 March, 2018 from: https://www.cfr.org/report/regulationexecutive-compensation-financial-services
  5. Kay, I., (2009, June 8). Regulating CEO Pay Is Not the Answer. Retrieved May 2, 2018, from: https://hbr.org/2009/06/ceo-pay-regulation-can-do-real.html
  6. Pepper, A., (2016, March 07). Time for change in executive pay? LSE Department of Management. Retrieved 01 March 2018, from: http://blogs.lse.ac.uk/management/2016/03/07/time-for-change-inexecutive-pay/
  7. Sky News, (2017, February 17). Debate: Are executives paid too much? Retrieved May 2, 2018, from: https://www.youtube.com/watch?v=GjEZVQrlC-k
  8. TUC, (2016, September 11). The UK’s highest paid CEO earns the average annual salary in under 45 minutes, TUC analysis finds. Retrieved May 2, 2018, from: https://www.tuc.org.uk/news/uk’s-highest-paid-ceo-earns-average-annual-salary-under-45-minutes-tuc-analysis-finds

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