Critical Thinking Paper: Executive Compensation

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Table of Contents

Introduction
Issue
Competing Claims
Criteria
Reasons and Evidence
Quantifier
Conclusion
Works Cited

Introduction

In recent years, management scholars, policy makers, and mainstream media commentators have debated over the high levels of executive compensation, inquiring whether they are consistent with other important variables such as shareholder interests, firm performance, national and international economic projections, and employee pay (Gong 1; Moriarty 235).

Although most advocates of the high levels of executive compensation, especially for CEOs, argue that the suitability of compensation is determined through the market process of wage negotiation rather than a simple process of introspection (Kaplan 5; Kolb 679), it is the interest of this paper to demonstrate that CEOs are grossly overpaid despite the incapacity of many to deliver long-term results for the organisation.

Issue

The problem is that CEOs are grossly overpaid as an incentive to deliver long-term results for the organisation, yet available literature demonstrates that the current compensation practices for CEOs in many countries globally only motivate them to maximise short-term profits at the expense of long-term benefit (Gong 2), hence the need for governments to implement regulations to limit executive compensation.

Recent statistics demonstrate that “in 2006, the median total compensation of the top U.S. CEOs was $10.1 million. This is 314 times the $32,142 earned by the median full-time private industry worker in the U.S. in 2006” (Moriarty 235). Yet, despite the high compensation packages for CEOs, majority of the executives are unable to maximise the value of the firms’ revenues while minimising costs (Kolb 679-680).

Competing Claims

While many scholars have argued against the high compensation practices for CEOs, a substantial number argue that executives are rightly remunerated since pay for the typical CEO is to a large extent driven by existing market forces.

Jeffrey Moriarty, cited extensively in executive pay literature, projects a valid argument that CEOs must respect their fiduciary duties, and therefore must be morally obligated “to reject excessive compensation from the firms they lead, even when such compensation is the outcome of an entirely arm’s length negotiation” (Kolb 679).

This scholar argues that organisations may be unable to maximise their value and competitiveness due to high compensation practices for CEOs, hence calls for a minimum effective compensation or “maximum morally permissible compensation” necessary to attract, retain, and motivate CEOs to maximise the value of the organisations in the delivery of long-term results.

Additionally, it is common practice that CEOs receiving very high compensation packages would forego a project with positive net present value (NPV) if such a project causes them to fall short of the current quarter consensus forecast, and instead choose to invest in a short-term project that generates higher short-term returns in order to illustrate a perception of greater ability and hence justify their hefty payouts and market value.

In the long-term, however, “stock price will drop due to sacrificed long-run profit for short-term profit, and CEO wealth will be negatively affected when the CEO holds a large number of stocks or stock options” (Gong 2). This assertion demonstrates why financial institutions, such as Frontier Bank and First Commercial Bank, have failed despite being led by highly remunerated CEOs.

A major counterargument is that “while CEO pay has increased substantially since the early 1990s, the pay of other talented and fortunate groups has increased by at least as much” (Kaplan 6). Additionally, advocates for high CEO pay suggest that it would be immoral to reduce the pay when all indicators demonstrate that the productivity of a country’s economy has increased considerably over the years (Bogle 23; Ozkan 262).

Criteria

The recent credit market turmoil, corporate scandals, as well as the abuse of the 2008 golden parachute clause, provides the basis for claiming that CEOs are grossly overpaid despite their incapacity to deliver long-term results for their respective organisations.

Reasons and Evidence

It can be argued that hefty pay packages for CEOs do not translate into extemporary performance for the firm as well as enhancement of shareholder value in the long-term (Moriarty 238). In the recent credit market turmoil, CEO Charles Prince of Citigroup lost his job after the financial service firm lost hundreds of millions of dollars in poor performance related to prioritising short-term profits over long-term profits (Kaplan 6).

In 2007, the second-highest paid Wall Street boss, Stanley O’Neil of Merrill Lynch, was forced to resign after running the financial institution to a near collapse due to shaky mortgages. Available figures indicate that O’Neal’s 2006 pay was approximately $48 million, second on Wall Street only to the $54.3 million earned by Goldman Sachs Group Inc. CEO Lloyd C. Blankfein” (Associated Press para. 9).

In 2008, James Cayne of Bear Stearns was left with no option than to sell his shares in the troubled investment bank for a meagre $61 million (from a net worth of more that $1 billion), not mentioning that Bear’s shareholders suffered profound losses after the firm’s forced sale to JPMorgan Chase (Thomas para. 1-2). Although Cayne took home $34 million in pay, the former CEO and Board Chairman engaged in corporate malpractices to conceal the true state of affairs at Bears before its collapse (Kaplan 8).

It can also be argued that overpaying CEOs and other board members does not translate into well-run and managed organisations that have the capacity to improve shareholder value and performance over the long-term. Despite having highly remunerated CEOs at the helm, Enron and WorldCom collapsed due to financial scandals related to insider trading and shady accounting practices (Moriarty 237).

Their collapse demonstrates that the CEOs never practiced value-based management (Avantika 29) and that the pay-for-performance strategy normally used to calculate pay packages for CEOs is not necessarily functional (Bogle 22; Ozkan 260). Further afield, the morale of many employees and shareholders is adversely affected by collapsing firms when they employ the Golden Parachute clauses to give substantial benefits to a CEO in the event that one firm is acquired by another, or the CEO’s contract is terminated immaturely (Banker et al 5).

For example, ex-Merrill CEO Stanley O’Neil was given a lump sum of $161.5 million when the investment bank went under even after critics questioned his role in worsening the financial performance and shareholder value of the firm (Associated Press para. 1).

Quantifier

The above reasons, along with the alluded evidence, validate the argument that CEOs are grossly overpaid despite their incapacity to deliver long-term results to the organisation, and the scenario is worsened by the fact that CEOs ultimately receive huge allowances during the termination of their contracts even after putting their respective firms on a path towards obscurity.

Conclusion

From the analysis, it is evident that huge pay packages for CEOs do not necessarily translate into capacity to deliver long-term results for the organisation in terms of performance and improvement in shareholder value. The case scenarios highlighted (i.e., Merrill Lynch, Bear Stearns, Citigroup, Enron and WorldCom) are a sharp indicator of the difficulties in linking high executive compensation to positive firm performance and improvement in shareholder value.

Although advocates of high executive compensation cite market forces as the main reason for this trend, stakeholders need to take caution not to remunerate CEOs highly for short-term gains while compromising the long-term benefits of the organisation.

Works Cited

Associated Press. “Ex-Merrill Lynch CEO to Walk Out with $161.5M.” NBC News 30 Oct. 2007. Web.

Avantika, Tomar. “Global Recession and Determinants of CEO Compensation: An Empirical Investigation of Listed Indian Firms.” Advances in Management. 4.12 (2011): 27-37. Business Source Premier. Web.

Banker, Rajiv D., Maseko N. Darrough, Rong Huang and Jose M. Plehn-Dujowich. “The Relation between CEO Compensation and Past Performance.” The Accounting Review. 88.1 (2013): 1-30. Business Source Premier. Web.

Bogle, John C. “Reflections on CEO Compensation.” Academy of Management Perspectives. 22.2 (2008): 21-25. Business Source Premier. Web.

Gong, James Jianxin. “Examining Shareholder Value Creation over CEO Tenure: A New Approach to Testing Effectiveness of Executive Compensation.” Journal of Management Accounting Research. 23.1 (2011): 1-28. Business Source Premier. Web.

Kaplan, Steven N. “Are U.S. CEOs Overpaid?” Academy of Management Perspectives. 22.2 (2008): 5-20. Business Source Premier. Web.

Kolb, Robert. “Must CEOs be Saints? Contra Monarty on CEO Abstemiousness.” Business Ethics Quarterly. 21.4 (2011): 679-691. Business Source Premier. Web.

Moriarty, Jeffrey. “How much Compensation can CEOs Permissibly Accept?” Business Ethics Quarterly. 19.2 (2009): 235-250. Business Source Premier. Web.

Ozkan, Neslihan. “CEO Compensation and Firm Performance: An Empirical Investigation of UK Panel Data.” European Financial Management. 17.2 (2011): 260-285. Business Source Premier. Web.

Thomas, Landon. “Down $900 Million or More, the Chairman of Bears Sells.” New York Times 28 March 2008. Web.

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