An American Dilemma: The High Compensation of CEO’s


The generous compensation packages given to chief executives of large Fortune 500 companies are very controversial because these packages are rarely based on the company’s performance and often worth an exuberant amount of money. Job responsibilities of chief executives are great as they are the leaders of a company and make crucial decisions concerning company policy and strategy.  In order to obtain the level of talent a CEO offers, a corporation must offer them large compensation packages to stay competitive against rival companies. The total compensation packages for company executives include their base salary, benefits and stock options, which are often much more extravagant in comparison to the average worker of the firm. The importance and difficulty of their job warrant high but not astronomical compensation. John Rawls’s A Theory of Justice provides principles that deal with the social and economic inequalities in society like the pay gap between executives and lower employees. When companies are trying to determine the pay of their CEOs, it would be wise to apply the stakeholder theory by Edward Freeman. Stakeholders are very important in the success of the company and all stakeholders should be considered when making business decisions. By using the stakeholder theory, the boards will be able to balance the benefits and losses for everyone involved in the company. Employees want to feel that their salaries reflect the amount and quality of work they contribute to a company. Companies should have contracts with their CEOs for reasonable amounts of money that reflect their performance in the company and are in proportion to company profit.

Even though numerous chief executives have taken pay cuts in the recent years, their compensation packages are often still too large. CEOs took a collective pay cut of 15% in 2007 and another 11% in 2008 (DeCarlo, 2011). Even with the pay cuts in 2008, Larry J. Ellison from Oracle was the top earner with a $1 million in salary and $544 million in stock options (DeCarlo, 2011). Also, in 2010 the average chief executive’s pay for S&P 500 companies was $11,358,445. According to AFL-CIO, 299 CEOs from the S&P 500 companies received $3.4 billion in pay which could support 102,325 jobs paying the median wages for all workers (AFL-CIO, 2011). Figure 1 in the appendix shows the CEO’s pay as a multiple of the average worker’s pay. Even though in the recent years the CEO’s pay has decreased, it is still much greater than the average worker’s pay. The total compensation of CEO is now 343 times larger than a median worker’s pay (Domhoff, 2011). An extremely large gap exists between the average CEOs compensation and that of the hourly wage worker. This discrepancy in pay allows all CEOs and their families be in the upper class in any society. According to the U.S. Census Bureau, in 2009, the top 5% of households earned over $200,000 in income (U.S. Census Bureau, 2011). The average CEO in 2010 that earned $11,358,445 in salary would earn approximately 57 times more than 95% of all households in the United States. It is not necessary to be paying an individual such an enormous amount of money when 95% of families are able to live with $200,000 or less. In addition, there should be a moral limit on how much compensation an executive can accept as there are others in the firm whose hard work , result in a company’s success and profit.

John Rawls’s principles from A Theory of Justice can be applied to the compensation packages of chief executives to show how lopsided they are. Rawls has two principles of justice that ensures people’s rights, opportunities and income are equally available and distributed in society. The second principle applies to the compensation packages of chief executives because the principle discusses the social and economic inequalities in society. The second principle states “social and economic inequalities are to be arranged so that they are both (a) reasonably expected to be to everyone’s advantage, and (b) attached to positions and offices open to all.” (Rawls, 1971) By following this principle there wouldn’t be such a large inequality in the pay of two employees like an executive and an average worker. Rawls states that the income of two employees doesn’t have to be equal, but “it must be to everyone’s advantage” (Rawls, 1971). The chief executives are benefiting significantly more than lower employees because the current compensation packages for chief executives give them access to stock options and health benefits that are not available to anyone else. The lower employees are crucial to the productivity and profitability of any company and there pay should reflect their efforts. A company can make the income “to everyone’s advantage” by reducing the pay gap between the chief executives and the lower employees and having everyone’s income reflect their performance in the company.

The chief executive’s compensation package should reflect their performance in the company for a given year. The CEO of a company should not receive the same stock options and benefits when their company is struggling and losing money and when it is prospering. The chief executives make the final business decisions that determine the success of the company. They should be held responsible for failure and not continue to be rewarded during hard times. Unfortunately, many large companies do not place a value on the performance of the company when determining the compensation packages for the executives. For example, Richard Fuld at Lehman Brothers was able to earn $484 million in eight years while leading the company to bankruptcy. He continued to lose the company money while spending over $10 billion on year-end bonuses, stock buybacks and dividend payments. Mr. Fuld was too aggressive as a chief executive by investing in risky mortgages that had low interest rates (Ross and Gomstyn, 2008). CEOs of large companies, which include Bank of America and General Electric have also earned negative returns for their tenure but have received millions in compensation each year. Kenneth D. Lewis had a -16% total return rate for Bank of America over 6 years while earning $29.7 million in compensation. Jeffrey R. Immelt earned $14.4 million over 6 years in compensation from General Electric while having a -11% total return rate (Decarlo, 2011). Every year Forbes produces a list of the top ten worst CEOs that did not do their job adequately and lost their company a significant amount of money but still received a large amount of money.  A CEO that leads the company to bankruptcy or negative returns should not be financially rewarded above their base salary and be able to earn such a substantial amount of additional money.

When a company goes bankrupt, its effects are widespread and the lower employees suffer more than the executives. The lower employees depend on their salary for basic needs such as putting a roof over their heads and providing food for their families. These employees might be living paycheck to paycheck and being unemployed could have a great negative impact on their life style. A CEO like Richard Fuld would not be as greatly affected by his company going bankrupt as he has been paid such a large amount of money. Also, his chances of future employment and earning potential would be favorable due to his corporate experience and it is likely that he could easily obtain employment elsewhere. The average wage earner would have a significantly more difficult time obtaining employment elsewhere as he does not have a resume with similar executive skills. Companies are wasting the money of the stockholders and not valuing the time and effort of stakeholders when they continue to pay these executives so extravagantly for a poorly done job.

The stakeholder theory states that corporations should hold their fiduciary relationship with their stakeholders over the needs of the stockholders. A stockholder is an individual or group that owns shares in a firm which allows them to have certain privileges (Freeman, 1991). A stakeholder is an individual or group of people that have a claim in a firm. A stakeholder in a corporation refers to the suppliers, employees, local community, management and the owners. Stakeholders should be allowed to provide insight regarding decisions about where the company is heading in the future. When companies only consider their stockholders, they make decisions based purely on financial reasons. By only considering the company’s finances, they fail to take into account how their company is affecting the community’s welfare as well as employee work satisfaction. The stakeholder theory states that a corporation is most effective when they balance and take into consideration the benefits and negative effects of each business decision for each stakeholder (Freeman, 1991). By balancing the needs of the stakeholders, the firm has a healthy working environment and is the most productive.

The most difficult task for managers in a corporation is balancing the needs of the stakeholders while striving to attain financial success.  A corporation’s management team has the responsibility of balancing the benefits and losses of all the stakeholders. Many top fortune 500 companies do not balance the benefits and losses in regards to the salaries for employees. Employees should feel like their salary and benefits are an accurate and fair representation of the labor an employee gives to the company. Freeman explains that “in return for their labor, they expect security, wages, benefits, and meaningful work” (Freeman, 1991). Employees should be able to live comfortably and be able to pay for their essential bills. Companies could use a portion of a CEO’s compensation package to pay their employees more and as a result the employees would have greater motivation to work hard. Another way to use the money from the compensation packages is to expand their business by creating more jobs which would help our country’s economy. A business could also invest the money back into their company by putting more money into research and development. These innovative changes would be advantageous and create a more productive team oriented work environment. CEO’s earn an excessive amount of money each year and it is not necessary for a company to spend that much on one individual when the work of many are needed for success and profitability of the firm.  By applying the stakeholder theory, companies would balance the salaries and benefits of all their employees, including those at the executive level.

Martin Weitzman, an economist from M.I.T., proposed an interesting solution in 1986 that would reduce the inequality in pay between the chief executives and the rest of the stakeholders. The solution is called “Stakeholder Pay”, which is a system that determines the income of the lower employees by the company’s monthly profit (Abernathy, 2011). The employee’s income is determined by multiplying a company’s profit index by the employee’s monthly base salary. For example, company A’s profit index could be between 75% and 150%. If an employee in company A has a base salary of $3,000 a month then their income would be determined by multiplying $3,000 by the profit index. If the company’s profits are very low than an employee’s monthly income would be computed by multiplying $3000 by 75% to get $2,250. But if the company’s monthly profit is exceptionally high for a month then the employee’s income would be computed by multiplying $3000 by 150% to get $4,500 (Abernathy, 2011). “Stakeholder Pay” motivates employees to work harder because they can earn more than their normal salary if the company has a high monthly profit. The “Stakeholder Pay” gives employees a potential benefit that is not available to chief executives and the extra benefit could minimize the pay gap between executives and other workers. Employees would be more committed to the company and therefore be more concerned about company’s overall profitability.

The current compensation packages of chief executives are controversial because of the chief executives crucial role with a company. Even though CEOs do not need such an outrageously large compensation package, they do deserve to be compensated better than the average worker. Also, organizations need a highly paid individual to aspire the lower employees to try to move up and to attain a higher position. It doesn’t matter if it’s the chief executive or an average worker, everyone’s salary and benefits should reflect their performance in the company. It is unfair that current CEOs can receive so much money from a company even when the company is doing poorly. The current compensation packages like stock options encourage a short term mindset which is not sustainable for a company. Even though a chief executive is very important to a company’s success, there should not be such a large gap in salaries between them and the average worker. If companies considered the stakeholder theory then it would balance everyone’s benefits and losses which would lessen the gap between the top executives and the average worker. It would be advantageous for companies to use their money in the most effective and efficient matter, whether it be employee’s salaries or in research and development, to make their company as successful as possible.

References

“2011 Executive PayWatch.” Aflcio.org – America’s Union Movement. Web. 23 Oct. 2011. <http://www.aflcio.org/corporatewatch/paywatch/index.cfm&gt;.

“The 2012 Statistical Abstract: Income, Expenditures, Poverty, & Wealth.” Census Bureau Home Page. U.S. Census Bureau, 27 Sept. 2011. Web. 23 Oct. 2011. <http://www.census.gov/compendia/statab/cats/income_expenditures_poverty_wealth.html&gt;.

Abernathy, Bill. “Stakeholder Pay: An Alternative Compensation System That Reduces Unemployment and Stabilizes Profit Margins | PM EZine.” Home | PM EZine. 8 June 2011. Web. 31 Oct. 2011. <http://pmezine.com/Stakeholder_Pay&gt;.

DeCarlo, Scott. “What The Boss Makes – Forbes.com.” Information for the World’s Business Leaders – Forbes.com. 22 Apr. 2009. Web. 23 Oct. 2011. <http://www.forbes.com/2009/04/22/compensation-chief-executive-salary-leadership-best-boss-09-ceo-intro.html&gt;.

Domhoff, G. William. “Who Rules America: Wealth, Income, and Power.” UC Santa Cruz – Sociology. July 2011. Web. 23 Oct. 2011. <http://sociology.ucsc.edu/whorulesamerica/power/wealth.html&gt;.

Freeman, R. Edward. “Stakeholder Theory of the Modern Corporation.” Business Ethics: the State of the Art. New York: Oxford UP, 1991. 38-48. Print.

Ross, Brian and Gomstyn, Alice. “Lehman Brothers Boss Defends $484 Million in Salary, Bonus – ABC News.” ABCNews.com: Daily News, Breaking News and Video Broadcasts – ABC News. 6 Oct. 2008. Web. 23 Oct. 2011. <http://abcnews.go.com/Blotter/story?id=5965360&gt;.

I used Mike Cardinute’s blog, “Over paid and under performed!”, for ideas about my paper.

Appendix

Advertisements
This entry was posted in Business, Cases (Real World), Equality, Ethics, Society and tagged , , , , , . Bookmark the permalink.

3 Responses to An American Dilemma: The High Compensation of CEO’s

  1. Jordi says:

    Would reducing pay gap be still inequality “to everyone’s advantage” if and only if that move increased the performance of the firm or entity? In other words, if wealth is a fixed pie, and your suggest simply changes the size of each stakeholder’s piece, but does not increase the size (amount), then is it an inequality that is justified by helping all? Does Rawls imply inequality with no benefit nor harm is acceptable?

  2. Jordi says:

    Has stakeholder pay been implemented anywhere? I can imagine many boards tossing out a CEO who pursued this because they expect that wealth to go to the shareholders. How can a board buy into examining the possibility?

  3. Jordi says:

    What is the dilemma?

What do you think?

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s