CEO Compensation Strategy: merits of high comp, regulatory pressure, performance

Read Case 7, “CEO Compensation”, then answer all five questions on pages 255-256.

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. 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. Another includes $58.5 million to the CEO of US Surgical Corporation. 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. Even severance packages 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 Crysta, 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.

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. 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% to other factors. Further, other critics have pointed out the vast differences between the US and other countries in ratios of CEO compensation to the average worker’s compensation. Reports indicate that CEO compensation in some US 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 US.

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 US 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 US should move to a German style of codetermination 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 CEOs compensation is 25 times greater than the average for blue collar workers.

Several other recommendations are directed toward implementation at the organizational level. One is to link CEO pay to log 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. The 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. 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 has proposed that stock option grants be reflected on financial statements as a charge to earnings. 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.

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. What non regulatory pressures are most likely to bring excessively high CEO salaries more in line with realistic levels?

4. Evaluate the argument that pay for performance justifies the level of compensation paid to CEOs noted in the examples.

5. Evaluate the argument that the problem of excessive CEO compensation should not be addressed through legislation.

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