What are the Ethical Issues Underlying Executive Compensation?
Last week the Wall Street Journal reported that CEO pay is rising moderately and awards are increasingly tied to future financial performance. But that doesn't apply to everybody.
The Wall Street Journal's annual compensation survey found that, for all the debate around high CEO pay, the biggest rewards go to a relative handful of executives at the very top, and that their pay doesn't necessarily correlate to their company's size or results.
This year's survey looked at 2013 compensation for CEOs at 300 large, U.S.-traded public companies. It found the top 10% by pay earned 23% of the total compensation, while the bottom 30% accounted for just 13% of the total. Pay across the survey rose by a median 5.5% to $11.4 million, nearly two-thirds of which was tied to performance.
The increase trailed the companies' median profit rise of 8% and median total shareholder return of 34%, which includes stock gains and dividends. It did, however, outstrip growth in compensation for ordinary employees. Wages and salaries for U.S. private-sector workers rose an average of 1.8% in 2013, according to the Labor Department.
Propelled by a soaring stock market, the median pay package for a CEO who worked at a publicly traded company rose above eight figures for the first time last year. The typical CEO now makes 257 times more than the average worker, whose wages have barely budged in recent years.
The three highest-paid CEOs— Oracle Corporation’s Larry Ellison, CBS Corporation’s Leslie Moonves and Liberty Global’s Michael T. Fries —made a total of $188 million, more than the combined pay of the 50 CEOs at the bottom of the same list.
From an ethical perspective, the question is whether it is fair and just that CEOs make so much more than the average worker? Can it be justified by any ethical rationale? To answer this question we need to examine how CEO pay is determined.
In the U.S., corporate governance is based on Agency Theory. That is, the top managers (i.e., CEO and CFO) are the agents of shareholders who are the principals because of their stock investment. Managers are supposed to make decisions that are in the best interests of the entity and, therefore, the shareholders and not their own self-interests. The idea is by providing incentive compensation in the form of bonuses and stock options (recall that nearly two-thirds of CEO pay packages are tied to performance), top management will work hard to improve the results for the entity thereby leading to higher stock prices that helps to maximize shareholder wealth. Of course, the higher results should come from improved operations and not from manipulating the financial statements as occurred at Enron and WorldCom.
The checks and balances in the system come from the board of directors that makes the final decision on CEO compensation. If the board approves a specific pay package, then regardless of the (excessive) amount of compensation, the pay packages meets corporate governance standards.
What can shareholders do if they believe executive compensation packages are excessive? A good example is the combined salaries of Chipotle’s Mexican Grill Inc. co-CEOs. The almost $50 million executive pay package proved to be something shareholders couldn’t swallow. Nearly 77 percent of shareholders of Chipotle voted against the compensation package at the annual meeting. The problem is these votes are only advisory. It is up to the board of directors to reign in excessive pay packages. Chipotle officials say they will take “seriously” such a strong expression of shareholder unhappiness with the pay at the Denver-based chain, even though the vote was only advisory. Among those criticizing the company’s compensation structure were the California State Teachers Retirement System, CalPERS, the New York City Pension Funds and the Florida State Board of Administration.
Shareholder skepticism for executive pay packages reflects an ethic of fairness. How can CEOs make so much when the average employee makes so little – and the disparity shows no sign of decreasing any time soon.
There is another view of top executive pay that may support CEO pay packages. LeBron James makes about $19.1 million a year while the lowest paid player on the NBA champion Miami Heat, Norris Cole, makes $1.1 million. That reflects about a 200:1 ratio. So, is that the absolute best in his/her field should make that much more than the lowest paid player? Doesn’t this support the 257 ratio between the average CEO and workers? Perhaps it does but that doesn’t mean it’s acceptable in the corporate world because shareholders are the principals and it’s their dollars at stake whereas with most sport teams it’s the private owner who makes those decisions presumably in the best interests of the team.
Blog posted by Steven Mintz, aka Ethics Sage, on June 3, 2014
Dr. Mintz is a professor in the Orfalea College of Business at Cal Poly, San Luis Obispo. He also blogs at: www.ethicssage.com.