كـليـة إدارة الأعــمـال
College of Business Administration

Written by:
Abdalaziz Saad Alamry

ID number:
JAB083

Course code:
HRM 450

Section number:
(1)

Subject:
Research on “Is Executive Compensation Fair?”

Is Executive Compensation Fair?

Executive pay (also executive compensation), is financial compensation received by an officer of a firm. It is typically a mixture of salary, bonuses, shares of and/or call options on the company stock, benefits, and perquisites, ideally configured to take into account government regulations, tax law, the desires of the organization and the executive, and rewards for performance. Over the past three decades, executive pay has risen dramatically relative to that of an average worker's wage in the United States, and to a lesser extent in some other countries. Observers differ as to whether this rise is a natural and beneficial result of competition for scarce business talent that can add greatly to stockholder value in large companies, or a socially harmful phenomenon brought about by social and political changes that have given executives greater control over their own pay. Executive pay is an important part of corporate governance, and is often determined by a company's board of directors.
Types of compensation
There are six basic tools of compensation or remuneration. * salary * short term incentives (STIs), sometimes known as bonuses * long-term incentive plans (LTIP) * employee benefits * paid expenses (perquisites) * insurance
In a modern corporation, the CEO and other top executives are often paid salary plus short-term incentives or bonuses. This combination is referred to as Total Cash Compensation (TCC). Short-term incentives usually are formula-driven and have some performance criteria attached depending on the role of the executive. For example, the Sales Director's performance related bonus may be based on incremental revenue growth turnover; a CEO's could be based on incremental profitability and revenue growth.
Bonuses are after-the-fact (not formula driven) and often discretionary. Executives may also be compensated with a mixture of cash and shares of the company which are almost always subject to vesting restrictions (a long-term incentive). To be considered a long-term incentive the measurement period must be in excess of one year (3–5 years is common). The vesting term refers to the period of time before the recipient has the right to transfer shares and realize value. Vesting can be based on time, performance or both. For example a CEO might get 1 million in cash, and 1 million in company shares (and share buy options used). Vesting can occur in two ways: "cliff vesting" (vesting occurring on one date), and "graded vesting" (which occurs over a period of time) and which maybe "uniform" (e.g. 20% of the options vest each year for 5 years) or "non-uniform" (e.g. 20%, 30% and 50% of the options vest each year for the next three years). Other components of an executive compensation package may include such perks as generous retirement plans, health insurance, a chauffered limousine, an executive jet, interest free loans for the purchase of housing, etc.
Levels of compensation
The levels of compensation in all countries has been rising dramatically over the past decades. Not only is it rising in absolute terms, but also in relative terms. In 2007, the world's highest paid chief executive officers and chief financial officers were American. They made 400 times more than average workers -- a gap 20 times bigger than it was in 1965. In 2010 the highest paid CEO was Viacom's Philippe P. Dauman at $84.5 million The U.S. has the world's highest CEO's compensation relative to manufacturing production workers. According to one 2005 estimate the U.S. ratio of CEO's to production worker pay is 39:1 compared to 31.8:1 in UK; 25.9:1 in Italy; 24.9:1 in New Zealand.
Controversy
The explosion in executive pay has become controversial, criticized by not only leftists but conservative establishmentarians such as Ben Bernanke Peter Drucker, John Bogle, and Warren Buffet.
The idea that stock options and other alleged pay-for-performance are driven by economics has also been questioned. According to economist Paul Krugman,
"Today the idea that huge paychecks are part of a beneficial system in which executives are given an incentive to perform well has become something of a sick joke. A 2001 article in Fortune, "The Great CEO Pay Heist" encapsulated the cynicism: You might have expected it to go like this: The stock isn't moving, so the CEO shouldn't be rewarded. But it was actually the opposite: The stock isn't moving, so we've got to find some other basis for rewarding the CEO.` And the article quoted a somewhat repentant Michael Jensen [a theorist for stock option compensation]: `I've generally worried these guys weren't getting paid enough. But now even I'm troubled.'"
Defenders of high executive pay say that the global war for talent and the rise of private equity firms can explain much of the increase in executive pay. For example, while in conservative Japan a senior executive has few alternatives to his current employer, in the United States it is acceptable and even admirable for a senior executive to jump to a competitor, to a private equity firm, or to a private equity portfolio company. Portfolio company executives take a pay cut but are routinely granted stock options for ownership of ten percent of the portfolio company, contingent on a successful tenure. Rather than signaling a conspiracy, defenders argue, the increase in executive pay is a mere byproduct of supply and demand for executive talent. However, U.S. executives make substantially more than their European and Asian counterparts.
Ten most international companies CEO’s compensations 1. Apple CEO Tim Cook was the highest-paid chief executive at a public U.S. company in 2011 with total compensation of $378 million. After becoming CEO in August 2011, Apple had record profits in the first quarter of $13.06 billion. Equilar, an executive compensation data firm, compiled a list of CEO pay of companies with revenue over $5 billion that filed annual proxy statements by March 30, 2012. 2. Oracle CEO Lawrence Ellison had the second highest CEO pay in 2011 with $77.6 million in total compensation, according to Equilar. Ellison's pay increased 11 percent from the previous year. Forbes' 2012 third richest person in the U.S. and the world's sixth richest with a net worth of $36 billion, he has been CEO of the software company since he founded it in 1977. 3. Ron Johnson, who became CEO of retailer J.C. Penney in November 2011, is Equilar's third highest paid chief executive with $53.3 million in total compensation. Credited with pioneering Apple's retail store and its Genius Bar tech support as that company's senior vice president of retail operations, he is tasked with transforming J.C. Penney Company, which reported a loss in the fourth quarter. 4. Viacom President and CEO Philippe Dauman had the fourth highest CEO compensation with $43.1 million, a drop of 49 percent from last year. Dauman has been chief executive officer since Sept. 2006 at the media company, which saw first quarter profit drop by 65 percent as reported in Feb. 2012 amid lower ad sales at its cable networks like Nickelodeon. 5. Honeywell International Inc. CEO David Cote had the fifth highest pay at $35.3 million an increase of 138 percent from 2010. Cote has been CEO of the technology company, which manufactures everything from defense to consumer security products, since Feb. 2002. Based in Morristown, N.J., it had stronger than expected third quarter net income of $862 million, up from $598 million the previous year. 6. Stephen Chazen of Occidental Petroleum Corp. had the sixth highest pay in 2011 with $31.7 million. Chazan has overseen the fourth largest oil and gas company in the U.S. since May 2011. Based in Los Angeles, Occidental had net income of $1.63 billion in the fourth quarter as reported in Jan. 2012, up from $1.21 billion a year earlier. 7. Robert Iger, president and chief executive officer of The Walt Disney Co., had the seventh highest CEO compensation in 2011 at $31.4 million, up 12 percent from the previous year according to Equilar. Iger has been chief executive at Disney, which owns ABC News, since 2005. Disney reported first quarter net income increased to $1.46 billion from $1.3 billion the previous year. 8. Clarence Cazalot Jr., president and chief executive officer of Marathon Oil Corp., had the eighth highest CEO compensation in 2011. Cazalot has been CEO of Marathon, based in Houston, since 2002. Net income for Marathon dropped to $549 million in the fourth quarter as reported in Feb. 2012 from $706 million in the previous year. 9. Alan Mulally, president and CEO of Ford Motor Co., had the ninth highest pay at $29.5 million, up 11 percent from the previous year. Leading since September 2006, Mulally oversaw Ford during the "auto-bailout" controversy through 2008. The Dearborn, Mich.-based company reported $13.62 billion in fourth quarter earnings in Jan. 2012, in part due to accounting, up from $190 million a year earlier. 10. Rupert Murdoch, chairman and CEO of News Corp., had the tenth highest pay at $29.4 million, up 75 percent from the previous year. Its defunct U.K. tabloid News of the World overshadowed public relations for the company, which owns Fox and Dow Jones, with a hacking scandal. Nevertheless News Corp. had second quarter earnings of $1.06 billion, up 65 percent from $642 million the previous year.
Why executives are paid so much?
Common answers to this question are, “We have to pay that much or they wouldn’t work for us,” “We just pay the going rate, the same as everyone else,” or “That’s what it costs to hire someone to do the job.” Of course, if the question were that easy to answer, executive pay would not be criticized as often as it is.
But those answers are untrue. Most executives would not quit their job if they were paid a bit less—at least not until they accepted a better paying job. Many hospitals and health systems pay more than the going rate, and those that intentionally position pay above the median cannot claim that they only pay the going rate. Most organizations pay more than they would have to pay to hire someone to do the job; people who could perform the job reasonably well and who would be willing to do so for less than the person chosen are in ample supply.
The dynamics of decision making on executive pay differ from the dynamics of other purchasing decisions, and they often lead organizations to pay more than they need to. Boards and CEOs do not let cost stand in the way when they are recruiting executives.
They often decide whom they want to hire before they begin to discuss pay. They sometimes come around to admitting that they cannot afford to hire their first choice, but they just as often end up paying whatever it takes to get their first choice to take the job.
Most discussion of executive pay is based on the assumption that pay is set by labor market dynamics. This ignores the fact that most pay decisions affect what incumbents are paid, not what external recruits are paid. Employers voluntarily give executives raises every year. They voluntarily enhance benefits and perquisites from time to time and sometimes increase incentive opportunities for no compelling reason.
Three principal factors drive executive compensation to today’s level:
1. The intent to hire the best talent available for the job.
2. The intent to pay competitively enough to retain incumbents.
3. The intent to pay above average in expectation of above average performance.
The intentions begin with the board’s decision to hire exceptionally talented, highly experienced executives and continue with the board’s willingness to pay the salary required to hire and retain them. External recruiting tends to drive pay up. When organizations recruit seasoned executives from other, similarly sized organizations, they generally need to pay well above average, more than they would need to pay to promote an internal candidate.
The intent to pay competitively drives up salary even for internally promoted executives and incumbents, however. Organizations whose policy is to pay at median increase pay faster than the rate of inflation for any executive paid less than median, and organizations whose policy is to pay at the 75th percentile continuously increase executives’ pay to stay ahead of the pack.
The intent to pay above average in expectation of above-average performance drives up pay for all executives, whether or not they are performing at an above-average level. Standard salary administration practices call for bringing salaries up to the intended level within a few years, as long as the incumbent performs reasonably well. Furthermore, incentive plans tend to reward institutional performance more than individual performance, so even average performers end up being paid above average.
The reasons executives are paid as much as they are have more to do with logic and belief than necessity:
• Organizations pay supervisors more than they pay their direct reports. They pay managers more than supervisors, department heads more than managers, executives more than department heads, and CEOs more than other executives. Organizations believe that higher-level jobs carry more responsibility than lower-level jobs do and therefore warrant higher pay.
• Following the same logic, bigger organizations tend to pay more than smaller organizations pay. Executives in bigger organizations have more responsibility than their counterparts in smaller organizations and therefore warrant more pay. Most US organizations follow this logic, as do most consultants who advise boards on executive compensation. The results of most executive compensation surveys reflect it as well.
• Hospitals are big organizations—bigger than most other organizations in small and midsize communities—so hospital executives have unusually big responsibilities. In many communities, hospitals are the biggest employer and often the biggest business, as measured by operating expenses. If only for that reason, one should expect hospitals to pay more than the smaller businesses in the same town do.
• Hospital executives’ jobs are unusually complex and challenging due to the nature of a hospital’s services, the risks entailed in making mistakes, the regulations governing healthcare, and the difficulty of collecting payment for the services provided.
So healthcare organizations hire experienced people, who have worked long enough in healthcare to know what needs to be done.
• Boards want highly qualified executives managing their hospitals to mitigate the risks involved in providing clinical care in a heavily regulated and litigious environment. They want to avoid relying on the less experienced executives they would be able to hire if they were to pay less.
• Boards believe they need to pay at median—the 50th percentile—or above to attract high-quality executives, so they intentionally position salary ranges at or above median and offer competitive levels of incentive opportunity and benefits. Almost every organization adopts such a policy and commits to paying more for executive talent than half of its peers—those paying below the 50th percentile—and trying to remain reasonably competitive with those that pay above the median.
• Boards want to maintain good morale on the executive team.
They believe they can do so by paying the CEO well, making sure that she is satisfied with her pay, and generally acceding to her requests for raises and bonuses for other executives.
In their book Pay Without Performance: The Unfulfilled Promise of Executive Compensation, Bebchuk and Fried (2004, ix) claim that a structural flaw in governance—an imbalance in power— gives CEOs too much influence over their own pay and impedes the effective governance of executive pay. “The absence of effective arm’s-length [bargaining with executives over compensation]—not temporary mistakes or lapses of judgment—has been the primary source of problematic compensation arrangements.”
While apologists for executive pay have attempted to discredit
Bebchuk and Fried’s argument (see, e.g., Kay and Van Putten 2007), anyone who has experienced compensation committee meetings appreciates the predicament Bebchuk and Fried’s argument represents. Directors are expected to make decisions in the best interests of the corporation, the shareholders, or, in the case of a local not-for-profit organization, the community. When determining executive compensation, however, they often seem to put executives’ interests ahead of those of the organization, unless the best interests of the organization are to maintain harmony in the boardroom and morale in the executive suite.

Why else would directors agree to pay bonuses to cover executives’ tax obligations on benefits and perquisites, eliminate or relax vesting requirements on supplemental retirement benefits, lend the hospital’s money to executives to finance deferred compensation in a split-dollar insurance scheme, or adopt countless other approaches to delaying or minimizing tax obligations on deferred compensation?
As long as they are pleased with performance, directors tend to be more generous with CEOs’ compensation than CEOs are with the pay of their direct reports. Many committees tend to approve whatever pay or benefits the CEO recommends for other executives because they are accustomed to following the CEO’s leads in most areas and regard decisions on pay for other executives as management’s turf, not the board’s. Directors often regard the CEO as a peer (the CEO is usually a director, too, and due to technical competence, the real leader of the board in most areas), so committees often find it difficult to maintain an arms’-length relationship with the CEO in governing executive compensation.
Executives are paid as much as they are paid because they are in great demand. Hospitals all want to recruit and retain outstanding leaders, and they are willing to pay well to get them and keep them.

References
Books
* Lucian Bebchuk and Jesse Fried, Pay without performance: The Unfulfilled Promise of Executive Compensation (2006)
Journal articles * Frydman, Carola; Saks, Raven E. (2007-01-18). "Historical Trends in Executive Compensation 1936-2005". * Bebchuk, Lucian; Grinstein, Yaniv (April 2005). "The Growth of Executive Pay". Harvard University: John M. Olin Center for Law, Economics and Business. * Yoram Landskroner and Alon Raviv, 'The 2007-2009 Financial Crisis and Executive Compensation: An Analysis and a Proposal for a Novel Structure' * Paolo Cioppa, 'Executive Compensation: The Fallacy of Disclosure' * Kenneth Rosen, 'Who Killed Katie Couric? And Other Tales from the World of Executive Compensation Reform' (2007) 76 Fordham Law Review 2907 * Carola Frydman 'Learning from the Past: Trends in Executive Compensation over the Twentieth Century' (2008) Center for Economic Studies
Newspaper articles * Sean O'Grady, 'Economist Stiglitz blames crunch on 'flawed' City bonuses system' (24.3.2008) The Independent * Louise Story, 'Windfall Is Seen as Bank Bonuses Are Paid in Stock' (7.11.2009) New York Times * '"Chief executives' pay rises to £2.5m average' (4.8.2005) The Guardian
Websites
* http://abcnews.go.com * http://www.ache.org