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IP 4: CEO Compensation
Many readers have probably had a conversation in which a friend or coworker expressed amazement at the extremely high compensation of some chief executive officers
( CEOs). Inevitably, there is a question of how such huge amounts of compensation can be justified. A notable example includes the Walt Disney Corporation’s CEO who
received $ 203 million in one year. 1 Another includes $ 58.5 million to the CEO of U. S. Surgical Corporation. 2 Still another includes a signing bonus of $ 10
million and $ 180 million in stock options for the incoming CEO of Global Crossings who resigned after one year. 3 Even severance pack-ages for some CEOs are huge. The
former CEO of Mattel resigned after substantial financial losses in the previous quarter and was given a $ 37 million package and over $ 708,989 per year for the
remainder of her life. Graef Crystal, a noted critic of CEO compensation, has spent a great amount of time studying the subject. For example, in his study of CEO
compensation in health care organizations, in which there is great variance in compensation, he found no rationale according to organizational performance or size.
Further, he discredited supply and demand explanations and attributed CEO high compensation to other sources of power. 4 Some of Crystal’s conclusions are as follows:
So is there any rhyme or reason to explain the huge variation of CEO pay levels? Short answer: Forget i t . . . There’s no justifiable theory on a shortage of CEO
talent to drive up CEO pay. But there is a creditable theory at work, the theory of CEO power. Pack the board with your friends, hire consultants who are good at
blowing smoke, float a lot of statistics about how other companies offer their CEOs a ton of money, and, voila, you, too, can make a lucrative sum no matter how you
perform, and see your pay rise at a rate faster than people who fill other important jobs in the organization. 5 On the other hand, there are defenders of current
levels of CEO compensation. Consultants Ira Kay and Rodney Robinson have argued that the pay of CEOs is justified by the performance of their companies. Further, they
have pointed out that academic research studies using time series methodologies provide the basis for such conclusions. 6 Even Crystal has found a small positive
relationship between performance, in the form of shareholder returns, and CEO compensation. He has found that such performance explains only 19.8 percent of the
variance in their compensation, however, which leaves approximately 80 percent to other factors. 7 Further, other critics have pointed out the vast differences between
the United States and other countries in ratios of CEO compensation to the average worker’s compensation. Reports indicate that CEO compensation in some U. S.
companies is now 200 times higher than that of rank- and- file employees whereas others indicate that the ratio has risen as high as 475 to one. When compared to other
industrialized countries, the ratios are much higher in the United States. 8 Because of the problem of excessive compensation, several recommendations have been
proposed. Some are very high- level policy recommendations, which would require legislation. One such recommendation is that the U. S. Glass- Steagall Act of 1933,
which prohibits bankers from sitting on their customers’ boards of directors, should be amended to permit such practices. Presumably, such bankers would be more cost
conscious. A radical policy recommendation is that the United States should move to a German style of code-termination system in which worker representatives sit on
boards of directors. In contrast, another recommendation is to avoid solutions that are based on legislation because they are likely to introduce even more problems.
Still another is that tax deductions should be disallowed for companies in which the CEO’s compensation is 25 times greater than the average for blue- collar workers.
9 Several other recommendations are directed toward implementation at the organizational level. One is to link CEO pay to long- term profitability. A second is to put
more stockholders and workers on boards of directors. A related recommendation is directed toward members of company boards of directors. That recommendation maintains
that board members should ignore self- serving surveys that portray CEOs as underpaid in comparison to other CEOs. They also should be very skeptical of assessments
concluding that CEOs are mobile. Still another recommendation is to use succession planning to develop an internal pool of qualified CEO candidates and thereby avoid
seeking expensive replacements from the external labor market. 10 A final recommendation would attack the problem in a more indirect manner. In response to the
problems of excessive CEO compensation, as well as other factors, the Financial Accounting Standards Board (FASB) has proposed that stock option grants be reflected on
financial statements as a charge to earnings. 11 Without such a requirement, stock option grants to executives, which may eventually take on millions of dollars in
value, are never reflected in financial statements.
Questions
1. Explain the potential adverse impacts on strategy implementation when the CEOs of companies receive extremely high compensation.
2. Discuss the merits of the various recommendations for solutions to the problem of extremely high CEO compensation.
3. 3. What nonregulatory pressures are most likely to bring excessively high CEO salaries more in line with realistic levels?
4. 4. Evaluate the argument that pay for performance justifies the level of compensation paid to the CEOs noted in the examples.
5. 5. Evaluate the argument that the problem of excessive CEO compensation should not be addressed through legislation.
