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Everything Wrong with CEO Compensation
  • May 2022
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Everything Wrong with CEO Compensation

28th May 2022

The topic of CEO compensation is fairly popular in the business press and is a subject of debate in and outside the business world. For many, this is a thorny issue that just becomes more controversial with time.

Since the financial crisis that happened  more than a decade ago, politicians, business   sustainability think tanks, and the media have grown to be more aggressive in calling out the egregious pay decisions and bonuses of the executive level employees in big businesses.

In her commentary titled 'What's Wrong With Executive Compensation?' for Project Syndicate, Lucy P Marcus, CEO and founder of Marcus Venture Consulting, and a speaker who is vocal for her talks on corporate governance, raised a question whether the compensations for CEOs are justified or not. Writing for Huffpost UK, she asks- 

“Why is it that executive pay continues to seem so out of line with what common sense would tell us is justified?”

There have been numerous cases over years where the compensation packages of many executive members, when revealed to the public, were met with disapproving and appalled reactions. In her blog ‘How Executive Pays Gets so Out of Control: Boards Are Tone Deaf in a Soundproof Room’ for Huffpost UK, the keynote speaker for corporate governance, Lucy P Marcus, shed light on some of the examples of cases where disclosing CEO incomes brought upon negative reactions of people.

“We've seen a number of striking examples over the past several months of compensation packages that, when exposed to the light of public scrutiny, evoke a range of negative reactions, making people anywhere from mildly annoyed to genuinely appalled. The packages seem out of line with results, and pay ratios are striking. Recent cases are unbounded by sector or location and include AstraZeneca, Barclays Bank and Shell.”

In another article for Project Syndicate, she gives more examples stating a clear distaste for the exorbitant packages- “But ignoring shareholder sentiment is becoming untenable. Discontent cuts across all sectors, from banking, with calls for a review at Lloyds Bank, to media and advertising, with an outcry, yet again, about the pay awarded to WPP’s Martin Sorrell; at £70.4 million, his latest package makes him the United Kingdom’s highest-paid CEO. At Berkshire Hathaway’s AGM in April, Warren Buffett advocated for compensation plans that fit the needs of the business, rather than vice versa. This happens when a “very greedy chief executive…designs a pyramid so that a whole bunch of other people down the line get overpaid… just so it doesn’t look like he’s all by himself, in terms of that fantastic pay-off he’s arranged for himself.”

Further in her Huffpost UK blog titled ‘How Executive Pays Gets so Out of Control: Boards Are Tone Deaf in a Soundproof Room’, the Thinkers 50 "Future Thinkers" Award winner Lucy Marcus asks a question-

“So what happens in the boardroom that lets such a package emerge?”

The answer to her question calls for an explanation that the CEO or executive level pays are indicative of more deeply engraved problems in the shareholder first system that exists in most of the public organizations. The main objective of companies with this system is to generate profits for shareholders and as a result, most of the executive level pay is tied to short term gains in stocks instead of long term stakeholder investments or innovations. Marcus also elaborates the remuneration issues stating

“In most board structures, a remunerations committee is assigned to set the level of compensation and determine the components of the pay package that senior executives receive, including base pay, bonus, stock and privileges such as use of the company jet. In recent years this committee assignment has gone from fairly light to as time-consuming as the audit committee.”

Often known as the voice setting the agenda on future proofing boardrooms and companies around the world, Lucy P Marcus further elaborates on remuneration problems in her commentary for Project Syndicate, titled ‘What’s Wrong With Executive Compensation’. She states- “Part of the issue is that executive remuneration packages have become too complex. Gone are the days when CEOs did the job and were paid a wage. It is almost as if remuneration committees have taken a leaf from Sun Tzu's The Art of War: “The whole secret lies in confusing the enemy, so that he cannot fathom our real intent.” Explanations for remuneration calculations can run for pages, and often board members who aren’t on the remuneration committee cannot unravel them.”


Statistics on CEO Compensation

Reports state that in 2020, a CEO of one of the top 350 firms in America was paid $24.2 million as average compensation. This number is an 18.9% increase from the highest CEO compensation paid in 2019 (which was possible due to rapid growth in vested stock awards and exercised stock options).

The statistics also show that in 2020, the ratio of CEO-to-employee compensation was found to be about 351 to 1, which is a huge leap from 307 to 1 in 2019, and 21 to 1 at the start of rapid industrialization in 1965.

CEOs are making more than six times as much than the higher paid employees at organizations. Since 1978 till present, CEO compensation has grown by 1322% and it might reach ridiculously higher if stakeholder interests are not considered in business practices. To set a contrast, over the same time period, the compensations of average workers have grown by just 18%.   


How are the CEOs Compensated

CEOs and executive management are not only paid a salary as compensation; their compensation come in various forms. While most of the companies support the idea of paying the Chief Executive Officer on the performance basis, the concept used widely to justify the pay for performance is that the compensation of CEO reflects company’s performance.

This concept implies CEOs take on risk, and that their fortune depends on the rise and fall of the company. Often, salaries, bonuses, and stock packages are awarded to the Chief Executive Officers of many publicly traded companies. 

1. Cash or Base Salaries- CEOs are paid substantially when the company is doing well. Their base salaries are very high and can even go to $1million. However, even when the company performance is poor, CEOs are paid exorbitantly, often, at the cost of wages of average employees. 

2. Bonuses- Bonuses are essentially the base salary in disguise. Depending on the company, they may or may not vary with performance. A CEO having $1 million as salary may also receive a $700k bonus, if that bonus does not vary with their performance during the tenure, then the base salary of that CEO is really placed at $1.5 million.

3. Stock Options- Stock options are the trump cards to link the financial interests of the executives with shareholder interests. However, these are often flawed as a compensation. The risk with stop options can be very skewed. If the share prices fall, and investors lose money on it, the value of the company falls. 

4. Stock Ownerships- Common stock ownership is the most important performance driver in the corporate world. CEOs can tie their interests with the shareholder interests as they own the shares and not the options. This process ideally involves getting a work bonus with a definite intention of using the money to buy shares. 


Why Does it Matter

The CEO compensation is a matter of concern as an exorbitant CEO pay becomes a major contributor to the emerging inequality in the corporate world that could otherwise easily be dealt with. CEOs are compensated more because of their power to set the pay as a part of the company board.

The CEOs are also paid more as much of their pay is related to stock (more than 80% comes through stocks), and not to their workplace productivity and professional skills. Lucy P. Marcus explains it better through her blog post for Huffpost UK titled ‘How Executive Pay Gets Out of Control..’.

She states that there are several factors that come to play as the remuneration committee and board determines the CEO packages. Some of them include personal relations, advice from consultants, a disconnect from reality, and a lack of direct accountability. 

She elaborates on how it becomes a matter of concern- “Often compensation consultants are used to help determine the packages of senior executives. Although many make a sincere attempt to prepare a comprehensive view, taking into consideration peer groups, market pressure, and many other factors, they may not fully appreciate how such a package will appear to stakeholders. What they advise may seem fair in the vacuum of the boardroom or on paper, but oftentimes it does not reflect other realities and pressures on the company from stakeholders such as investors, employees and the community at large. Also, there is a real danger that consultants can become part of the problem, driving up compensation packages as they create an aura of ensuring that the CEO and senior team feel fairly compensated relative to their peer group - a sort of 'keeping up with the Joneses'.”

She also stresses on the need for reconsideration on the board’s part about CEO compensation- “Boards need to come to grips with compensation structures of their senior executive teams, and stakeholders need to continue to voice their concerns about compensation packages. CEOs and other members of the C-suite 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 and demonstrate that board members are not tone-deaf in a soundproof room.”


When and Where the Pay Gap Becomes Controversial

The pay gap between employees and CEO creates a rift between two positions and creates problems of inequality at the workplace. It also affects the ethical compliance of the organization as exorbitant compensations of executives linked with operational goals may lead to unethical and unlawful conduct on their part.

Applying deontological ethics and principles of fiduciary duties in the business structure throws light on the unjust current structure and levels of CEO and executive management compensations.

The columnist for Reuters on the intersection of boards, leadership, and ethics– Lucy P. Marcus also throws light on the issue in her commentary for Project Syndicate, titled 'What's Wrong With Executive Compensation?'. She states-

“Part of the issue is that executive remuneration packages have become too complex. Gone are the days when CEOs did the job and were paid a wage. It is almost as if remuneration committees have taken a leaf from Sun Tzu's The Art of War: “The whole secret lies in confusing the enemy, so that he cannot fathom our real intent.” Explanations for remuneration calculations can run for pages, and often board members who aren’t on the remuneration committee cannot unravel them.

Moreover, bonus targets are fundamentally flawed. Markets are fraught with “unknown unknowns.” Boards often don’t know now what will need to happen later. And that means goals based on the past or the supposed future reward what we currently think rather than actual performance.

When pay is driven by strict adherence to targets set 12 months before, CEOs look back, instead of focusing on the present and on what comes next. Compensation needs to reflect whether the CEO won all the battles but lost the war.

But avoiding what might be called the “Dudley Paradox” – a CEO is paid a huge bonus for hitting targets, even as the company suffers major losses – requires boards to stop delegating the entire pay discussion to the compensation committee and waiting for the decisions to arrive, fait accompli, tied up in a bow. The full board should review the company’s operations and strategy thoroughly; only then should the compensation committee set about creating the program to act on it.

Having such a program in place is especially important when a new CEO or senior executive is hired. At a time of great hope and a desire to woo the candidate, desperation or enthusiasm can lead to poor judgment and badly formulated packages, which, once negotiated, are not subject to shareholder vote. A prime example is Yahoo’s firing of Henrique De Castro in 2014. After only 15 months on the job as COO, De Castro walked away with $109 million.”


Implications of High Pay

The issue of high compensation is not only a problem of top management at companies receiving huge paychecks, but exorbitant pay also impacts the compensation structure throughout the company, and sometimes, even throughout the economy.

Apart from this, higher pay available in the corporate sector is a huge contributor to 'revolving door' officials problem, where people spend a few years in regulatory positions and then go work in the industry they regulate. This pattern leads to conflict of interest, ultimately leading to degradation of regulatory enforcement and an increment in the potential corruption in the company since the regulator might, intentionally or not, court other employees of the firm.

The exorbitant pay that top management receives, comes at the expense of the employees at the middle and bottom step of the wage ladder.

If this goes on, a few years down the line, we would be looking at a totally different world in the context of income inequality, regulator quality, and corruption.


Changing rules of Corporate Governance

"The perception and accountability of the boardroom, and indeed the personal accountability of individual board members, has been transformed. Increasingly board members have to demonstrate why they have taken certain decisions or voted in a certain way, and remuneration committees are being asked to substantiate their choices. Boards need to come to grips with compensation structures of their senior executive teams, and stakeholders need to continue to voice their concerns about compensation packages." Says Lucy P. Marcus in her huffpost blog.

To solve the problem, the board and remuneration committees at corporations need to enact policy solutions that would reduce and limit incentives and rewards for executive management to extract concessions that are economically beneficial for them.

These policies must include reinstatement of higher marginal income tax at top management levels, setting a higher corporate tax for companies where ratio of CEO-to-employee compensation is higher, and regulations to limit firm’s as well as CEO's market powers. These policies should also allow inclusion of shareholders in committee meetings to decide the pay of the CEOs.

In the closing remarks for Project Syndicate commentary, Lucy emphasizes that it is also the responsibility of CEOs to be judicious about their compensations.

“CEOs should show leadership in how they manage their own compensation negotiations. If they are responsible for all aspects of the company, then they cannot abdicate responsibility with a “Because I’m worth it” attitude when news of their large pay packages becomes public. More important, they need to recognize that no law obliges them to take what they can get. They could hit the targets and earn the pay, but look at the company’s results and choose to adjust the total accordingly. The CEO needs to be talking about the business of the company to its workforce, investors, and the wider world, not be stuck at the AGM defending the executive team’s salaries.

The revolt against large pay packages won’t go away. For all the reported cases, many more are simmering beneath the surface of public scrutiny. Unless these companies address head-on the quiet hand-wringing among board members and grumbling among investors, they will find themselves on the front pages next.”



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