There are numerous examples of compensation packages that, when exposed to light of public scrutiny, evoke a range of negative reactions, allowing the public to find fault with not only the company, but the executives who are receiving those packages. CEOs are paid exuberant salaries for holding the top employment positions in the nation, and are expected to convey the necessary skills and responsibilities that come with the position. With limited roles for CEO positions that can be filled in our society, our market has determined that people with these skills are worth the compensation they receive. The American Federation of Labor and Congress of Industrial Organizations (AFL–CIO) has calculated that “The ratio of CEO-to-worker pay between CEOs of the S&P 500 Index companies and U.S. workers widened to 380 times in 2011 from 343 times in 2010. Back in 1980, the average large company CEO only received 42 times the average worker’s pay” (“Trends in CEO Pay”).
2011 Average CEO Pay at S&P 500 Index Companies
|Non-Equity Incentive Plan Compensation||
|Pension and Deferred Compensation Earnings||
|All Other Compensation||
Like the AFL-CIO, there are many other critics of executive compensation – those who believe there is something essentially immoral with a system that allows the CEO to make almost 400 times what the average worker makes. However, tracing pack to the leadership and resignation of previous CEO of General Motors Rick Wagoner, I evaluate that there is a moral element to the debate over CEO pay, and will take a closer look into the ethics behind the fairness of executive compensation policies.
The Great Debate
Like athletes and actors, CEOs provide a level of talent that is required to produce the desired product – in this case, a strongly performing company. The rationale is that if the company is performing well and the shareholders are making money, then the CEO should share in that success. One of the explanations for the compensation practices is that CEO pay sets the ceiling for the company. A CEO’s compensation package affects everyone within a company. Often it can be considered the measurement by which all other employee benefits and bonuses are negotiated. In the traditional internal equity method of establishing a pay structure, the CEO’s compensation sets a ceiling for the company, and each level below is compensated at a comparably lower level. Robert H. Frank from the “New York Times” suggests a proposal that “would cap the chief executive’s pay at each company at 20 times its average worker’s salary” (Frank 1). However Frank goes on to mention that “the link between pay and performance is tighter than proponents of pay caps seem to think” (Frank 2). He suggests that if CEO compensation would have a cap, the most talented potential managers would be more likely to become “lawyers or hedge fund operators”, suggesting that these positions – where unethical behavior is common – would take away the most talented candidates form the American economy (Frank 2).
Overview of Compensation Packages
CEOs also make most of their money through incentives. As a general rule, base salary accounts for just 20 percent of a CEO’s pay. The other 80 percent comes from performance-based pay. The base pay an executive receives is for the core role and responsibilities of the day-to-day running of the organization. Annual bonuses are given for meeting annual performance objectives. Long-term incentive payments are “included for meeting performance objectives to be achieved for a two- to five-year period”. These awards are sometimes described as performance shares, performance units, or long-term cash incentives. Restricted stock awards are also included as an incentive to “assure the executives are strongly aligned with the interests of shareholders”. Because restricted stock awards have an actual cash value when they are granted, “the proxy table shows these in dollars, not in shares”. Lastly, Stock options and stock appreciation rights (SARs) are included for increasing share price and increasing the shareholders’ returns (“Long Term Incentive Pay”).
While the list of entries in compensation packages seem understandable, debt ceilings, bailouts, economic downturns, stocks plummeting and cost-cutting layoffs have become daily realities in today’s economy, and have brought to light the add-ons listed as “Other Compensation” that make most of working America cringe – the same working America that is faced with rising unemployment, pay cuts and the very real probability of losing their jobs. Often lost among the large sums paid out as salary, bonuses, and stock options are special compensations for valuable services that very few people can afford — what is most commonly known as perks. Many public companies provide services, at no charge, to their CEOs, ranging from the use of private corporate airplanes to accounting services and security details. The value of these perks can add well into the hundreds of thousands of dollars a year for some chief executives. Alexis Kleinman from The Huffington Post lays out eight outlandish Perks:
|Private Use of Corporate Aircraft||$ 913,966||Barry Diller||IAC/InterActiveCorp. (NASDAQ: IACI)|
|Security||$ 2,611,873||Sheldon Adelson||Las Vegas Sands (NYSE: LVS)|
|Signing Bonus||$ 53,000,000||Ron Johnson||J.C. Penney (NYSE: JCP)|
|Use of Car and Driver||$ 572,596||Ralph Lauren||Ralph Lauren (NYSE: RL)|
|Personal Accounting||$ 250,000||Aubrey McClendon||Chesapeake Energy (NYSE: CHK)|
|Life Insurance||$ 131,280||Leslie Moonves||Company: CBS (NYSE: CBS)|
|Vacation/Vacation Home||$ 453,382||William P. Foley II||Fidelity National Finance (NYSE: FNF)|
|Personnel Costs||$ 83,327||Martha Stewart||Martha Stewart Living Omnimedia (NYSE: MSO)|
Rick Wagoner: The Man who Lost GM
The list of executives receiving these types of perks in addition to the base salaries goes on and on. However, I would like to fixate on George Richard “Rick” Wagoner, Jr., the American businessman and former Chairman and CEO of General Motors. Wagoner became president and chief executive officer in June 2000 and was elected chairman on May 1, 2003. Under his leadership, GM suffered “losses in Wagoner’s last four years which topped $80 billion” (Flint 1). In April 2005 Wagoner took back personal control of GM’s North American car division in light of its poor performance, and in early June 2005, Wagoner announced that GM in the United States would close several plants and shed “25,000 jobs which represent about 17 percent of GM’s U.S. work force, which includes 111,000 unionized employees and another 39,000 salaried staff” (Isidore 1). GM (Research) stock rose as much as 2.4 percent following the announcement, but showed only a 1.4 percent gain in the last hour of trading. When considering the fall of GM, a number of factors can be attributed. He made astoundingly bad product decisions, such as supporting the poor-selling Pontiac Aztek and cancelling GM’s early move into hybrids. By losing over $80 billion in just four years, and with his cash management so poorly regulated, that GM’s debt was properly downgraded to junk-bond status. However, despite complex institutional factors accounting for GM’s collapse, Wagoner will be known as the man who lost GM. Many remember the scandalous Big Three auto CEOs that “flew private jets to Washington to request taxpayer bailout money” (Levs 1). Wagoner was one of the three executives to step out of the plane. GM spokesman Tom Wilkinson said in a statement: “”Making a big to-do about this when issues vital to the jobs of millions of Americans are being discussed in Washington is diverting attention away from a critical debate that will determine the future health of the auto industry and the American economy,” and proponents of GM argued that the private jets needed to be utilized for safety reasons (Levs 1). Wagoner was asked to step down by Steven Rattner, the investment banker picked by the Obama administration to lead the Treasury Department’s auto-industry task force. Wagoner made “$14.4 million in 2007, mostly in stock, restricted stock, and stock options that likely won’t fare well as GM equity and bondholders line up to take their restructuring haircuts”(Maiello 1). He still received millions in cash and cash bonuses for 2007. In nearly 32 years with the company, Wagoner accrued pension benefits that the company valued at $22.1 million at the end of last year. Wagoner is also entitled to $366,602 in unvested stock awards and “$534,627 in deferred compensation as of Dec. 31, according to GM’s annual report” (Maiello 1).
From the beginning of his career at GM through the end of 2008, Wagoner received compensation totaling about $63.3 million, with $38.7 million of that coming during his years as its chief executive. In the subsequent paragraph, I will examine whether or not giving Wagoner the boot for his performance was justified.
The Ethics behind the Debate
In The Myths and Realities of Executive Pay, Ira Kay and Steven Putten evaluate the myths behind executive compensation, and investigate whether the pay for performance model actually governs executive pay levels. The book goes on to assess the relative success of the pay for performance model in creating shareholder value and job growth for U.S. employees, and provides a detailed plan on designing an effective executive compensation plan. The authors analyze that there are multiple perceptions of executive compensation. The first views compensation as reasonable to the pay for performance model, and is characterized by “high pay for high performance and less pay for lower performance” (Kay & Putten 1). They deem the topic an “economic juggernaut, resulting in trillions of dollars of wealth for shareholders and substantial income and net worth for corporate employees and their families” (Kay & Putten 1). This argument is concurrent with Gabaix and Landier’s viewpoint that “the best CEOs manage the largest firms, as this maximizes their impact and economic efficiency” (Gabaix & Landier 49). Gabaix and Landier analyze the evolution of CEO pay, and offer their three-pronged reasoning to justify the compensation practices over time. Their first explanation attributes the rise in CEO compensation to the widespread adoption of the compensation packages discussed earlier. These incentives, they argue, need to be put in place “due to increased volatility in the business environment faced by firms” (Gabaix & Landier 51). They explain there is a link between increased competition and “higher pay-for-performance sensitivity in US CEO compensation”. They have also linked rise in compensation value to the rise of in stock-based compensation following the “leveraged buyout revolution” of the 1980s” (Gabaix & Landier 52). The second view explaining the rise in CEO compensation is attributed by an “increase in managerial entrenchment, or loosening of social norms against excessive pay” (Gabaix & Landier 52). Lastly, the third explanation is attributed to the change in the responsibilities of the CEO. They argue that the rise in pay reﬂects tighter corporate governance. To compensate CEOs for the increased likelihood of being ﬁred, their pay must increase” (Gabaix & Landier 53). Kay and Putten would agree with the final explanation, in the sense that executive compensation is fair because our executives are worth at least their base salaries. They explain that US executives are among the best and brightest in the world, and are even sought after by foreign companies to “improve earnings and efficiency” (Kay & Putten 4). It seems Kay and Putten believe that all of the great economic benefits we’ve enjoyed in this country during the past two decades or so can be traced back, in no small part, to the way we pay our chief executives. Additionally, only a few people make it to the coveted role of “CEO” and they become the face of the corporation in most cases, as well as personally accountable for the practices and success of the company. CEOs spend a copious amount of time dealing with regulations specific to their field. If these corporations are generating billions of dollars in revenue, treat their employees ethically, and meet the demands of their shareholders, is it actually wrong for a CEO to be compensated handsomely for keeping the company afloat and in smooth sails? Obviously Rick Wagoner would not be an example of this.
The contrasting perspective sees the pay for performance model as a failure, resulting in “immorally high and rising executive pay unrelated to corporate performance” (Kay & Putten 1). Fed most notably by a series of financial and personal scandals, the media has “whipped the perception of a failed pay model into a full-blown mythology of a corporate America ruled by executive greed” (Kay & Putten 1). Lavish executive lifestyles have been castigated by the public even accusations of underperformance appear commonly. While Kay and Putten argue that, “the U.S. corporate model and the executive pay practices that drive it have created investment returns for millions of shareholders”, Jeffrey Pfeffer would argue that “the pursuit of shareholder return has distorted corporate behavior by forcing a more short-term focus” (Kay & Putten 4, Pfeffer 149). Pfeffer criticizes executives for spending too much time on “share price fixation” and obsessing over shareholder return that they focus less on employees. Spending “II percent of their time on corporate governance and administration” is unethical in Pfeffer’s view, and I would argue that if executives are paid top dollar to do a well-rounded job, they should at least take their employees into consideration (Pfeffer 148). He argues that “Leaders need to reliably measure the processes that produce competitive success and not obsess about a measure, the stock price, that seems to be neither particularly reliable nor valid” (Pfeffer 153). As the former CEO and chairman for Procter & Gamble, A.G. Lafley would also agree with Pfeffer’s argument that straying away from short-term satisfaction should be the goal for any executive making the salary they do. He emphasizes “longer-term value creation” and offers his critique on unfair compensation of CEOs as well. Lafley argues that executives should be “rewarded with equity”, should obtain a “meaningful portion of their company-awarded equity into retirement”, and should “implement and more detailed analyses” by ensuring that compensation should be provided in a full list of wealth accumulated (Lafley 1). Although criticized for his former position in the CEO chair, Lafley argues that executives who have acquired sufficient wealth over the years “need no security blanket”, therefore ascertaining fair compensation practices (Lafley 1).
If the market for executive talent is competitive, critics ask, why are CEOs in an industry paid about the same, regardless of performance? That’s because no one knows with certainty how a particular executive will perform. However, most hiring decisions are based on well-researched predictions, and always with hope for success. Executives whose record predicts good performance command a high rate. Their leash, however, has grown shorter. In the past, a CEO could often stay in the job for many years despite lackluster performance. Today, a CEO who fails to deliver is often dismissed after a year or two, or is personally asked to resign by the Obama administration like Wagoner in the GM case. In essence, one can argue that CEOs and other members of the executive communities (or the 1% as most would like to call them) deserve fair compensation for running companies, particularly in demanding economic times, when only organizations with the best talent will survive and thrive. On the other hand, these difficult economic times call for judicious decisions about compensation packages that are more clearly linked to performance.