Abstract
Executive Compensation is too high in almost all cases. This level of compensation affects all the levels of the company as there is a great disparity in the level of CEO compensation and the other employees of the company. In some cases employees have been let go because the CEO is the first to receive the large salary.
Executive compensation is determined in some cases by the competition. Consultants are used to extrapolate the compensation at various companies and relate it to the other CEO's as an effort to level the playing field. However many times a consultant uses the data from a much larger company to fix the compensation and therefore it is not equitable for the company that they are trying to establish. The inequality is usually not discovered because only the shareholders are privy to such data.
CEO's are highly trained individuals and their work is difficult. The movement within a company is usually the contingent factors that create the super high compensation packages. Movements, such as IPO's, mergers and acquisitions and other financial ventures that greatly increase the earning power of a company, are considered in part of the compensation of the executives.
In order to remain competitive, stockholders want to have the best person on the job especially leading the company. It is felt that in order to get the best person the financial reporting has to be attractive for the investors. At times the CEO's have committed fraud and misrepresented the financial position of the company in order to increase their own compensation. The classic case of the fall of Enron speaks to inflated financial reporting.
In conclusion the compensation of CEO's is going up. There does not seem to be a movement to equalize the compensation to a lower level across the board.
Introduction
Executive compensation is comprised on many incentives including financial, bonuses, and a whole package full if incentives. This add-on’s contributed to the total compensation package and in some cases exceeds the financial compensation. This paper discusses just the financial policy as it relates to executive compensation and the high rates that CEO’s receive in today’s economy. The trend continues for the CEO compensation to continue to move upward in the near future.
Compensation Justified by Performance
The top executives are under much pressure and it is absolutely not a job for everyone as it is very difficult. Additionally it is difficult to measure the performance of the CEO and the question arises as to whether it is tied into the financial performance of the corporation. A responsibility to the shareholders is one that needs to measure whether the performance of the highest paid employee is taking away from the profits of the company.
CEO performance reviews are a myth for the most part . The myth is that the CEO pay is driven by the competition when in actuality CEO compensation is driven by consultant reports. The problem here is that most consultant compare corporations of larger sizes and then the compensation appear higher. Since the CEO normally dominates the boards and directors in the corporation the decision about excessive compensation for the CEO very seldom makes it to the discussion table.
One example where the pay for performance philosophy has been used is in the Middleby Corporation case. In 2011 no one received a raise because the company did not achieve targeted markets. A pay for performance philosophy was adopted for the upper level managers and the CEO. In 2012, the company saw a significant change. In an economic downturn, Middleby’s finance turned upward. Costs were controlled, and sales went up. Therefore because there was a profit the upper level of management including the CEO received significant pay increases.
Some companies have gone to a pay for performance scenario that gives not financial concerns but equity in the company as the company’s performance increases. Equity compensation was enthusiastically received . This system allowed CEO’s to reap the benefits of spikes in the market that were related to market conditions and not necessarily to any initiatives that they sponsored.
The pay for performance model for CEO compensation attaches wages to the executive performance and it follows that as the company does well the higher payout to the executive will follow. Citigroup is a bank that offers this type of CEO compensation and in 2015 the CEO, Michael Corbit got a pay cut. This is after the firm disclosed a $400 million loan fraud. It appears as though this is pay for performance also. The performance was poor so the CEO was punished and received only a $1.5 million in salary and then the bonuses so the total was about $11.7 million even with the downturn.
CEO Compensation based on Market Conditions
The highest paid executive in the United States, according to CNN Money, is GoPro’s Nick Woodman . This 39 year old is paid $285 million in stock options for the product that is trendy and hot now. Woodward received past of his compensation in terms of stock options and when GoPro took off in 2014-15 he stood to gain the most. Although he has not received all of these funds on paper, he has benefitted greatly due to positive market conditions. Woodward accomplished one of the highest IPO's in history and still the question exists as to whether it is too much, too little or what is the right price.
The basis of the pay for CEO’s on market conditions produces unfair compensation rates in other ways. In deciding how much to pay their CEO’s many companies use outside consultants in order to get a fair and unbiased option. Of course these consultants are paid to report the best findings for their client. In an effort to be diligent many report the findings from companies that might be larger than the company that they are contracted with. This produces an unfair compensation package for the smaller company.
The following graph shows the effect of inequitable size comparisons . The example is given of a small cosmetics firm being grouped with Estee Lauder. The consultants advocated raising the pay of the smaller firm less than one million in sales to the level of the CEO of Estee Lauder over 150million in sales. The comparison is not justified and artificially inflated the market share competition principle. The old adage 'apples to apples' is apparently not in effect for CEO's.
1 Market share and CEO Compensation
Incentives to Cheat
Every day in the news another story breaks about white color crime of executives cheating shareholders on their profits or other sources of misconduct. These revelations of misrepresentation of finances or other wrongdoing can have disastrous effects on the people employed there in addition to the CEO. Jobs at a much lower level can be lost and divisions closed to cover the misconduct ensuing loss to the company.
Why would someone making this level of compensation put everything in jeopardy to cheat or misrepresent the finances? The plausible answer could be because their compensation is tied to the financial performance of the company. One study that proves this theory was conducted with the US Government Accountability Office . Empirical support for both incentive and relative performance irregularities were discovered. This is a sad commentary on the executive compensation that cheating may be necessary to make it look like they deserve the high compensation. John Rigas, 91 year old former head of Adelphia Cable was just in the news looking for a compassionate release from prison. He was one of the CEO’s who based his compensation on misrepresented financial data .
CEO compensation is too high
The average American family of four earns and lives on around $55,000 but the average CEO earns on the average of $22 million. The disparity is amazing. The issues that make the CEO pay so high goes back to the market conditions. The CEO’s don’t normally have long tern job security though. There is a connection between the highest paid CEO’s and the companies who have been making deals, going public, mergers and acquisitions and so forth. The ability to create an IPO offering and successfully take a company public earned Nick Woodman $77.4 million.
Family owned businesses have different compensation packages for CEO's that are founding family members versus those that are not . As a founding family member their pay decreases as the company goes through a lower performance level and then picks p as the company returns to a better financial path. The risk of being fired during a downturn is less likely though in a family owned business.
The Board of Directors of a family owned business or a public corporation have a Board of Directors whose job it is to oversee the CEO compensation and determine the appropriate salary to attract the talent that the corporation needs to provide them with dividends. The dismissal of a CEO who is not guiding the corporation in a positive manner is the responsibility of the Board also. But this does not happen very often. Evidence of the dismissal of CEO's for poor performance is only about 10%
Conclusion
Executive Compensation is too high as compared to any other level of worker. The competition helps to drive up executive compensation and sometimes it is not an equity comparison. Another unequal comparison is to assume that the assessments that are made to say that CEO's are paid too much are without reference points. Professional athletes, some lawyers, and some investment bankers make compensation to the level of CEO's. It would be wrong to assume that everyone is making good money now. This level of compensation begs the question as to why professional athletes deserve such a high compensation and most families cannot even afford the cost of a ticket. In the business world, a CEO can earn 1% of the total companies earning. Just one person earns such a large share and the other employees are forced to split the rest. This seems unfair for all the rest of the employees.
Envy is the underlying emotion when considering CEO compensation. Most people make an average salary and are envious of the earning power of a fortunate few. Many people take for granted the class system in earning potential is just a matter of the way things are. The factors that go into determining executive compensation are not important to most people. The concern is not how the salaried are computed the problem is that the CEO's make the millions and the average person does not.
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