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Introduction: An ordinary CEO lives in a heaven on Earth. A 7 figure salary perks piles of facilities; name a benefit, financial or non-financial, monetary or non-monetary, and the reader will observe it to be associated to a CEO. These three letters which might sound the juiciest to a student are the short form of Chief Executive Officer: the top person responsible for the operations of a company. Newsweek suggests that these personalities are being awarded salaries that had been climbing to 100 times the salaries of ordinary employees. Be it soaring profits, crushing bankruptcy, or off the records growths, the CEO's are the main persons to be accredited for a company's profits or losses. The question is: do they really worth a pay that huge?
The Growing Media Concern:
Barrett Sheridan of Newsweek has quoted Frederick Brook, a multinational consultant, that the propaganda about high payment to CEO's was in fact false and wrong. He justified the pay by saying that the CEO's need to be paid higher in order to keep them attached to the firm, and seek long term benefits and profits. Xavier Gabaix of MIT and Augustin Landier of NYU, have been quoted in the same article that since a CEO is that top personality which is found to be in very scarce and inelastic supply in the labor market, they are hence being paid high figured salary fairly complying to the laws of Demand and Supply. If a company is in need of a CEO who has had 15 years of related experience in a top managerial position in one of the leading multinationals of the world, then such people are found in a very very very short supply and with a very high demand for price, or the pay, so called. "If you have the talent to be among the best 500 in your field, you'll be rewarded accordingly."
Similarly, the article approves of the CEO pays by deeming them to be related with performance. It is no doubt a fact that as soon as they seat themselves as the Chiefs, CEO's have nearly always brought ground breaking changes in structures of a firm. Changing organizational structures, modifying communications, increasing staff motivation, whatever be it, they are determined to change the look of company, and above all, the delicious profits. When they represent the company and its shareholders with ever increasing profits, then it becomes their ultimate right to have a slice from it. "The bottom line is that to be more effective, pay structures are going to have to become more industry- and even company-specific," says Page, from Deloitte's."
How ever, an other article from the same Newsweek but a different issue says that companies are embarrassing themselves from the responses of the workers who have 142 times lesser salaries then their bosses, and shareholders who see a very huge proportion of their deserving profit, going into the bank accounts of the company CEO's. Shareholder groups are demanding more disclosure in financial statements regarding the benefits and perks taken by the directors and CEO's. These people take the same amount if increments whether the firm goes in a profit or loss. Sometimes, an increment is witnessed even in case of a loss. General opinion says that CEO's shouldn't be paid as much as they are being paid right now. The Directors and the CEO of a company sometimes get united and they approve a higher and highest pay for him who in turns blesses them with perks and benefits using his/her authority as the CEO. However, due to increasing pressure from outsider groups, CEO's are now inclined to a lesser basic pay, but a hoard of benefits.
The Remuneration Determination Process:
A remuneration committee is comprised of directors of the company who decide the pay scale and other facilities for the members of board of directors including the CEO. Sky touching pay increases for senior executives in the starting of 1990s brought remuneration committees under increased scrutiny. This culminated in the IRS introducing tax codes arising to the fact that this committee must be independent to claim executive compensation as a tax deduction (Anderson & Bizjak, 2003). The end of the economic boom of the 1990s and various scandalous practices of Enron, Walt Disney, Hollinger International and others again have focused attention of the public towards executive pay and the role played by the remuneration committee. The Sarbanes-Oxley Act of 2002 is a response to the questionable executive pay practices that includes a requirement for the companies to have a written code of ethics to which the chief executive officer (CEO), controller and chief financial officer must abide. NASDQ and the New York Stock Exchange (NYSE) have also adopted independent director rules for listed companies. (Gallo)
Corporate executive remuneration is highly visible now and decisions need to be disclosed as well as defended to shareholders, employees, and the public and in some cases, government institutions. Because of this increased general awareness and a stock market that has battered most companies' stock prices, remuneration committees are facing public and shareholder backlash around executive pays.(Gallo, Hellerman & Jones, 2003).
Arguably, this has lead to changes in the nature of work that is required on boards and more precisely on the remuneration committee. According to Korn/Ferry International's 30th annual Board of Directors Study, 23 percent of board directors on Fortune 1000 companies turned down additional board roles in 2002, compared to only 13 percent the previous year. Participants have expressed concerns about themselves getting involved in risky situations that could lead to damaging their reputations and having satisfactory time to take on more board duties. All of the participants expressed their concerns that the amount of time required to fulfill their board duties has increased very considerably. Indeed, PricewaterhouseCoopers found in an investigation that approximately two-thirds of corporate board members had reported spending more time on their board duties during the past year. To sublime the public outrage of outrageous levels of executive remuneration, and pay practices that are being deemed questionable, numerous public figures and authors have suggested changing the ways that corporate boards of directors cooperate (Cf. Bebchuk, 2004; Bertrand, 2003; Murphy & Hall, 2003; Reda, 2002). These changes have been specifically focused upon the remuneration committees, the directors who are most directly involved in innovating executive remuneration packages. The changes suggested by different opinions revolve around increasing the independence of the board and compensation committee from the CEO and senior company executives and increasing the diversity of perspectives on the board. More precisely, it has been suggested that the compensation committees:
Should comprise of independent directors (a non-executive director could fit for the purpose).
Should add a limit to the number of boards on which these personals serve.
Should be diversified in terms of knowledge and perspective.
Should directly employ any outside consultants and meet whenever it decides, with no company insider controlling the scheduling or agenda
Should create that type of remuneration packages that emphasize upon performance and do not just reflect data from market survey.
Should not allow the company to enter into employment agreements that have a term of more than three years and contain "evergreen" provisions with permissions for automatic renewal
Should design that type of agreements that allow them to reduce the amount of compensation paid for poor performance. (Anderson)
An article in the World-at-Work Journal (second Quarter 2005) revealed confidential comments from 21 remuneration committee members to better understand their thoughts about the recent changes in regulations and their role, and their determination if the suggested changes would really have taken place. The process and criteria for selection of board members has a major impact upon remuneration committee independence. The interview, as quoted in the Journal, revealed that the chairman of the board, who is usually the CEO too, typically assigns board members to the remuneration committee (and other board committees). All of the interviewees, who were questioned by the Journal, said that the most important criterion upon which a board member is judged and subsequently assigned to the remuneration committee is the person's character and reputation, which is very subjective and often difficult to define. Even though guidelines have been established with regard to selection of independent directors, they may not act independently as pointed out by Jeffrey Sonnenfeld (2004).
"Pay more minds to character than to independence. Shareholder activists have been pressurizing down their companies for supermajorities of independent external directors. But being independent is not the same thing as having independence." (p. 11)
With reference to the above lines, it would surely be interesting to note that only 24 percent of the interview participants felt that compensation committees needed to act more independently.
Recently, experts and governance authorities have recommended that consultants should work directly for the chairman of the compensation committee, without any guidance or input from the CEO or his respective staff. Furthermore, it has also been recommended that the CEO should not be present in the meetings of the remuneration committee and that he should not be required to set the agenda for these meetings. Although these suggestions have received considerable exposure in the news, public and press, 88 percent of committee members informed that the remuneration consultant still works directly for the CEO, even though 47 percent have acknowledged that this may not turn up to be a good idea. The sample remuneration committee members have suggested the CEO's involvement is vital because of the desire to effectively link business goals with executive pay. (Anderson)
Compensation Consultants and Conflicts of Interest:
There are various problems associated with having a remuneration consulting firm involved in other strategic aspects of the company's business (e.g., tax, auditing, human resource outsourcing contracts, legal, retirement benefit consulting or insurance) which have not yet received a great deal of publicity. But this issue has been causing problems for auditing firms. Arthur Andersen, Enron's famed auditor, has acknowledged that it did not challenge the financial practices at Enron because it did not seek to lose the juicy consulting contracts it had with Enron. Surprisingly, corporations are concerned about this potential conflict of interest problem, but not a single remuneration committee has discussed this issue. (Gallo)
One major element while determining CEO pay is data from market-based pay surveys. Regarding market-based pay, nearly all the organizations target to pay the 50th or 75th percentile of the market pay rate. No company, it seems, wishes to hire a CEO for less than the midpoint of the market. However, remuneration committees are now more closely examining market pay data for determination of know-how about the peer group chosen and whether the economics of the business support the data used from suggested counterpart groups. More than seventy-one percent of corporate board members across the USA believe that the rapid increase in executive compensation during the past 10 years has occurred due to the "ratcheting up" of survey data that occurs when many companies target the 75th percentile of the survey which leads to the 75th percentile quickly being the median of future surveys. However, it has been suggested that considerable emphasis is still placed upon market data rather than performance of the company in establishment of pay levels for executives. Severance agreements and Executive contracts have had substantial bad publicity and negative press in more recent years. It infuriates the public, company employees and investors when executives show failure to meet performance goals and continue to receive high levels of remuneration and incentives. Particularly infuriating are the large see-off packages for executives who are fired for unworthy performance. "I think that many compensation committees have been very, very sleazy in the past decade in accepting contracts of CEOs without knowing their contracts, and in remunerating those CEOs who have failed, and in awarding compensation arrangements whenever it is easy for the CEO to cash out with large gains just before the stock price collapses," said William W. George, the co-chair of the National Association of Corporate Directors, 2003 Blue Ribbon Commission on Executive Compensation and the Role of the Compensation Committee, and former Medtronic Inc. chair and CEO.
The Hay Group (2004) has reported that more than 67 percent of executives have a contract that provided them economical protection if they are fired. The attorney who represents the new CEO candidate invariably always stands in a strong negotiating position and assumes the power to craft the best possible package that can be obtained. To be short, survey participants of the previous interview (refer to above) have expressed their concerns trying to fight highly excessive contracts. In addition to rewarding the failed executives, 29 percent of the participants believed that a combination of outrageous executive contracts and large stock option grants have stimulated the executives to take unnecessary risks encouragingly. Executives enjoy the downside protection of their contracts and the large upside potential of the stock option grant. One stakeholder group that could have considerable influence over executive pay is the shareholder group, such as the California Public Employees' Retirement System (CalPERS). Priding to be the largest public retirement system in the United States, CalPERS' board of administration has reached to the conclusion that "good" corporate governance means leading towards improved long-term performance. CalPERS have a strong belief that good governance requires the dedication and attentiveness of not only a company's officers and directors, but also its owners. CalPERS regards itself not as simply a passive stockholder but: "a shareowner who takes seriously the responsibility that comes along with company ownership." Although shareholders like CalPERS are in the process of gaining power in the United States, their proposals against management typically lose. Investors mostly express their no confidence against the company by quietly selling their shares in the stock exchange. (Anderson)
The CEO pays in Context of Business & Economic Theory:
Indeed, it is a fact that the high set CEO pays of today are in line with economic theory. Considering the CEO as a typical human resource, it is in a clearly short supply. For example, there are a very few person on this mother earth, who have a privilege to be the CEO of beverage giant Pepsi Co. Hence the short supply of persons willing and able to work and able to work as a CEO, increases their market price or remuneration in corporate terms. (Parkin)
A simple demand supply chart can illustrate this problem.
Similarly, the Principal Agent problem presents a different issue but with the same pursuance towards high CEO remuneration. Also known as the Agency theory, it is the means of devising compensation rules that induce an agent (e.g a CEO) to act in the best interest of Principal (shareholder). The theory suggests that principals must induce of the managers to act in their (the shareholder's) best interest. The theory also states that issuing commands does not address the principal-agent problem. Hence, it is necessary to create incentives by the principal for the agents so that they can be induced to improve performance and increase profits. Since the CEO is the core of an organization, the agency theory legitimizes the CEO's very high pays and perks and so-called unfair long term contracts.
Maslow's theory of motivation highlights different criteria. Maslow's (1908-1970) based his theory solely on people in the working environment. He concerned with trying to identify and classify the main needs a human has. His human needs are summarized in the hierarchy given below in a top down approach. (Stimpson)
5-Physical Needs: Food, shelter, water, rest.
4-Safety Needs: Protection from threats: Job security, health and safety at work.
3-Social Needs: Trust, acceptance, friendship, sense of belonging.
2-Esteem needs: Respect from others, status recognition or achievement.
1-Self-actualization: Reaching one's full potential
It would be ridiculous to assume that any of the above mentioned needs of CEO are unfulfilled. However, as said above, as CEO's are of critical importance, their needs are concerned much sensitively, and it is required that they be fulfilled to their maximum.
The psychological contract theory is based upon expectations. It suggests that employees have certain expectations from their organization that in turn has expectations with them. Hence, it can be easily justified by supporters of outrageous CEO remuneration, that CEO's expect healthy rewards and incentives from the firm who in turn expects undulated efficiency, performance and improvement. It is a ground fact that that CEOs like Indra Nooyi (Pepsi Co), Vyomesh Joshi (Hewlett Packard), Steven Jobs (Apple) etc have brought ground breaking changes in their organization, changed their structures and enjoyed highest of all perks. (Hall)
The Equity theory suggests that individuals who feel that they are being under rewarded or over-rewarded will experience distress. The theory focuses to determine the fair distribution of resources within interpersonal relationships. It also assumes that employees seek to maintain equal ratio between their input to their organization and the outcomes they receive. Also, they compare their outcomes with others of their own class. Hence, owing to the current market trend, CEO's are being paid fairly as it is generally thought as a fair comparison between their peers. (Elsevier)
Although, the theories mentioned above all support the idea of outrageous CEO remunerations, it must be noticed that the practical field is entirely different from the theoretical areas. Hence the long debate discussed before this sub-section must be given equal importance.