Ceo Compensation Is A Economic Reward Commerce Essay Example

today's economy, chief executive officers (CEOs) are not the only highly paid individuals; unfortunately, their compensation is more visible because of disclosure regulations. Over the past thirty years, there has been a significant increase in the gap between CEO compensation and regular employees' pay. Before World War II, top executives earned approximately 63 times more than average net incomes. During the war, this ratio decreased significantly so that by 1945, top executives were earning 41 times more than mean net incomes. In the 1960s, CEOs earned around 40 times more than average employees, which increased to 107 times by 1990. According to The New York Times, these figures continued rising reaching 525 times in the following decade and slightly decreasing to 301:1 in 2003. The large disparity in executive compensation presents challenges for HR practitioners as concerns about equality and ethical issues arise.Extensive research has been conducted over the past century on the correlation between performance and compensation, resulting in around 250 studies (Tosi & co-worker, 1989). However, these studies have yielded disappointing results (Miller, 1995). Further research has explored various methods to analyze factors that influence CEO compensation. Despite this, there is still controversy surrounding the most important determinant of CEO pay – their attributes – and how exactly they impact executive salaries. The reliability of information on CEO compensation poses a problem as different research methods have led to disagreements. The demand for a comprehensive synthesis of CEO compensation determinants has increased due to globalization, workplace diversity, maximizing net income, and the decline of large companies. Despite this growing demand, there is still no consensus on whether CEOs deserve their high wages or

not. The issue of executive wage levels and structures remains a highly debated topic in both practice and theory. Arguments persist regarding how to explain executive compensation and whether executives are being overpaid. Executive pay receives significant media attention within the business world with frequent expressions of outrage over excessive salaries, bonuses, and financial benefits received by executives. In spite of ongoing turmoil, boards of directors continue to struggle with explaining the "how," "how much," and "why" behind executive compensation.The prevailing theory that justifies executive wages is the agency theory, introduced by Jensen and Meckling in 1976. According to this theory, executive pay acts as a mechanism for resolving agency problems by aligning shareholder and management interests through separating ownership and control of the company. Wage setting is seen as a process of developing an optimal compensation package based on market forces and individuals' risk preferences. Market forces determine appropriate wage levels and structures that adequately reward executives for the risks they undertake in managing the company in line with shareholder interests. Extensive literature explores the relationship between wages and performance, discussing three theories: agency theory, value attack, bureau attack, and symbolic attack. Despite variations, there are shared ideas when speculating about executive pay. Studying executive pay is crucial for understanding organizational processes as determining their salaries is influenced by corporate governance agreements and organizational procedures which also impact executive motivation along with lower-level employees' motivation.In order to gain a comprehensive understanding of executive pay, future explanations should shift their focus from solely examining the wage itself to considering all factors that contribute to its formation. By adopting this approach, three important implications regarding executive

wages can be uncovered. Firstly, it becomes apparent that wage setting practices primarily influence executive salaries rather than merely serving as a means of aligning interests between stockholders and executives. Secondly, those individuals involved in these practices possess significant discretion to not only impact their own wages but also the compensation of others and the mechanisms behind these practices. It is crucial to comprehend national corporate governance agreements in order to fully understand wage setting practices. These agreements are categorized based on various theories which explain the role of salary and provide justifications and mechanisms for determining wages within those theories. The value approach encompasses five distinct theories: 1) marginal productivity theory, 2) efficiency pay theory, 3) human capital theory, 4) opportunity cost theory, and 5) superstar theory. Of these theories, the most significant one is marginal productivity theory which perceives executives' services as inputs in production. According to this perspective, the value of these inputs is established by supply and demand within the labor market, with equilibrium wage being equivalent to the executive's marginal gross product.The text discusses various theories and approaches related to executive compensation. According to human capital theory, an executive's productivity is influenced by their accumulated knowledge and skills, known as human capital. Executives with more knowledge and skills have higher human capital. The efficiency pay theory suggests that executives will work harder if they are promised a wage above the market rate. This higher pay reduces turnover and the likelihood of sabotage, while also making executives feel valued by the company.

The opportunity cost approach states that executives can easily switch employers because job openings in their field are transparent. To

attract or retain executives, their wages must be equal to or greater than what they would earn elsewhere. The superstar theory addresses income inequality by stating that talented individuals cannot be perfectly replaced. Talented individuals can serve large markets and earn high incomes due to joint consumption and imperfect substitution.

Therefore, companies are willing to pay disproportionately high premiums for unique talents or capabilities without suitable substitutes, which explains the skewed distribution of executive wages. The agency approach focuses on determining the compensation levels of executives while also considering how they should be paidThis approach proposes that wage levels are primarily determined by the market value of executives' services. Pay is considered an outcome of agency jobs, where one party delegates tasks to another party. Within this perspective, there exist two distinct groups of theories regarding executive pay. One group argues that executive pay helps address agency problems by aligning incentives and transferring risk. The other group suggests that executive pay results from executives' discretion and can lead to deviations from agency problems. Despite their differences, both groups view executive pay as a tool to alleviate these issues.

Executives may be willing to take risks in certain situations to avoid losses or achieve specific goals. Symbolic justifications for executive pay propose that it serves as a socially constructed symbol reflecting the expected role, status, or function of executives within society or a company. Legitimization arguments for executive pay are based on socially and economically constructed beliefs about the roles of executives and how their pay should align with these roles.

The symbolic approach encompasses seven theories: tournament theory, frontman theory, stewardship theory, crowding-out theory, implicit/psychological contract theory, social

enacted proportionality theory, and social comparison theory. According to tournament theory (Lazear and Rosen, 1981), executive pay serves as a reward in a competitive environment.By offering significant rewards, individuals are motivated to strive for higher positions within the company (Rosen, 1986), leading to increased productivity among lower-level competitors (Balsam, 2002). Conversely, according to the figurehead theory, behavior in companies reflects intent and purpose when diverse goals and interests coexist (Ungson and Steers, 1984). Managers may be required to act as revivalists due to their multiple roles (Weick, 1979:42). The executive pay reinforces the perception of executives as figureheads both internally and externally from the organization's perspective (Gomez-Mejia ,1994).

In contrast with these perspectives is the stewardship theory that presents conflicting views on governance (Davis et al., 1997; Donaldson and Davis ,1991). It argues that executive pay does not necessarily need a strong correlation with shareholder wealth or other financial performance measures of the company itself(Davis et al., 1997 Schoorman & Donaldson ,1997 ). The crowding-out theory suggests that monetary incentives can potentially diminish intrinsic motivation while positively affecting intentions(Frey ,1997a ;Frey ,1997b ). Although compensation plays a role in executive motivation, it is likely overshadowed by organizational goal achievement. The delicate balance between intrinsic and extrinsic motivation is crucial.Excessive compensation levels and excessive external incentives can undermine executives' intrinsic motivation and lead to reduced efforts (Frey and OsterlA‘h, 2005). This can result in behaviors that are against the company's best interests, such as corporate fraud. According to implicit contract or psychological contract theory (1985; Kidder and Buchholtz, 2002; Baker, Gibbons, and Murphy, 2002), individuals have beliefs about their exchange agreement with another party. Relational contract theory

builds on social exchange theory and emphasizes principles of generalized reciprocity. Informal agreements and unwritten codes of behavior influence actions in these relational contracts (Baker, Gibbons, and Murphy, 2002). Compensation serves as a symbol of appreciation, achievement, and self-respect (Kidder and Buchholtz, 2002). The socially enacted proportionality theory suggests that an executive's value aligns with their position in the hierarchy. It is widely accepted for executives to receive higher salaries compared to their immediate subordinates. This concept extends to lower levels where externally hired employees' wages are determined by market competition. The societal comparison theory involves comparing executives internally and externally within the organizationAccording to this theory, executives use their own salary as a reference point when determining the salaries of other executives. This theory is based on the belief that individuals have a natural tendency to evaluate their abilities and options by comparing themselves to others with similar performance or ideas. When setting executive salaries, executives take into account factors such as the average salary and experience of other executives, as well as their own.

Various empirical studies have tested hypotheses from different theoretical models mentioned in literature reviews by Gomez-Mejia (1994). However, these studies have produced conflicting results that have implications for multiple theories. For example, there is an ongoing debate about the relationship between wages and public performance discussed by Rosen (1990). Some argue that this connection is not strong enough to support incentive claims, while others believe it exists and provides evidence for such deductions (Gomez-Mejia, 1994; Gomez-Mejia and Wiseman, 1997; Jensen and Murphy, 1990b).

Overall, empirical studies on executive wage determinants lack solid theoretical foundations and do not align well with the

data (Hambrick and Finkelstein, 1995; Mueller and Yun, 1997). In addition, it is important to acknowledge that scholars' biases and ideologies can impact the findings they present (Gomez-Mejia, 1994; Gomez-Mejia and Wiseman, 1997).When combined, these different theories offer deeper insights into executive wage and enhance our understanding of its legitimacy. Both the value approach and agency approach emphasize economic reasoning, pricing, and market mechanisms in determining executive compensation. They argue that market forces provide a solid foundation for explaining CEO pay and justifying their worth. However, relying solely on efficient market principles presents challenges in justifying executive compensation. The decision-making process within a company also has significance; markets alone do not have enough influence over wage decisions. Executives possess the power to influence the board of directors and the wage-setting process, especially when negotiating their own compensation. This passage suggests that executives can be categorized within society according to category hegemony theory, which focuses on power dynamics in different societal categories and how they impact corporate governance agreements and outcomes like wage levels and structures.Multiple economic theories on executive compensation also support this perspective. These theories often view individuals as isolated from their social and cultural context. However, all of these approaches present challenges and raise concerns regarding equity management and ethical considerations.

A case study involving Vikram Pandit illustrates this point. In 2008, Pandit became CEO of Citigroup after joining as Head of Investment Banking when his hedge fund was acquired for $800 million by Citigroup. Despite media headlines calling him "Citigroup's quarter billion dollar man," Pandit did not actually receive such a large sum of money.

The value of his hedge fund had significantly decreased

by the time it was liquidated in May 2008. When his restricted portions and stock options worth $40 million vested years later, their actual value was only $4 million.

The text discusses the deceptive nature of executive compensation figures and acknowledges that these packages can include cash and non-cash incentives that are collected over one or multiple years. It also recognizes that calculations, estimates, and limitations often lead to a different final value than expected.

The author agrees with Edwin Locke's argument that high salaries alone should not deem executives as overpaid but acknowledges the challenges faced in today's economy. The author believes that executives deserve their compensation due to the risks they take and the impact on their personal lives.Despite criticism and claims of excessive executive compensation not being tied to performance, the author disagrees and believes there are misunderstandings about this issue. The author acknowledges some flaws in executive compensation practices but argues that they are influenced by market forces and performance-driven factors. However, the perception that executive compensation has increased in recent years is not accurate. In fact, when adjusting for inflation, the average CEO salary has actually decreased since 2000 while salaries for other groups have risen significantly. The provided graph illustrates the average and median expected CEO salary for S 500 CEOs from 1994 onwards (adjusted for inflation). It shows that the average CEO salary has remained stable since 2001 without any increase, and even the median salary has experienced a notable decline. Notably, the average CEO salary in 2008 was lower than it was in 1998 (refer to Chart 1). As an HR Professional, if your employees start believing that the

organization's strategy prioritizes benefiting executives over shareholders and staff members, you face a serious internal strategic issue. Therefore, as an HR Practitioner, it becomes your responsibility to restore fairness to upper management and individual contributor compensation while maintaining trust and respect between both parties (Employer - employee).Based on my research, I find Rick Newman's 2009 suggestions regarding potential solutions most relevant in my situation. These solutions involve linking wages to long-term performance and implementing claw-backs. Linking wages to long-term performance addresses the issue of executives receiving large bonuses based solely on short-term results, without considering the company's long-term well-being. To minimize risks and negative consequences, compensation commissions should establish specific measures for evaluating long-term performance. Allowing claw-backs enables companies to recover CEO pay if unexpected problems arise after bonuses and compensation have been granted, discouraging CEOs from prioritizing short-term outcomes or hiding potential issues. Additionally, stockholders should have more involvement in decision-making through "Say on pay" rules that grant them an advisory vote on executive pay packages. According to The Conference Board, stockholders should carefully evaluate recommendations from proxy consultative firms before blindly approving consultative ballots on executive compensation. Furthermore, limitations must be placed on the practice of CEOs being paid based on their peers' earnings.Typically, companies hire external advisers to determine CEO salaries based on salary ranges of comparable firms. This often results in most CEOs earning above-average salaries and inflating the median wage for this group. According to Hewitt Associates, the average annual salary for CEOs is now $8.4 million.

The text emphasizes the need to limit extravagant perks given to CEOs, such as excessive severance packages, unlimited use of corporate jets, taxable fringe

benefits, generous death benefits for their families, and unauthorized payouts. One potential approach is to avoid controversial fringe benefits or payments and instead obtain stockholders' approval when uncertain about their appropriateness.

By adhering to these suggestions, the perception of executive compensation can be changed. When all individuals - including employees, stockholders, and stakeholders - have transparency into the process behind determining CEO pay, they will better understand and appreciate why CEOs deserve their remuneration.