CEOs PAID TOO MUCH ABSTRACT This paper explores the salary of CEOs which is being paid too much. The writer of Reader’s Digest, (Crowley, 2005) wrote an article and stated that Stephan Crawford, A CEO of a company in US, quit during a “management shake-up” and “strolled off with a severance package which included two year’s salary and bonus,” which amounted to $32 milion. He also pointed out that “Crawford pulled in 54,000 dollars per hour into his pocket! ” which is a huge amount of money.
However, (Kaplan, 2007) argued that there can be absolutely no doubt that the typical CEO in the United States is paid for performance and suggested that CEOs may not be overpaid but in fact, may be underpaid. In a May 2009 paper, Gabaix and three co-authors propose one possible solution for improving incentive structures where they suggest awarding executive pay through “dynamic incentive accounts. ” Keywords: CEOs, CEOs paid too much CEOs PAID TOO MUCH
A chief executive officer (CEO, US English), managing director (MD, UK English), or chief executive is the highest-ranking corporate officer or administrator in charge of total management of an organization. HarperBusiness author, (Drucker, 2005) proposes a definition of the CEO by saying that the CEO is the link between the Inside, for example “the organization”, and the Outside which are society, the economy, technology, markets, customers, the media and public opinion. Meanwhile, salary brings the meaning of a fixed compensation periodically paid to a person for regular work or services from the employers to the employees.
Then we also need to distinguish wealth from income and income is what people earn from work, but also from dividends, interest, and any rents or royalties that are paid to them on the properties they own. So in theory, those who own a great deal of wealth, but in reality those who are at the very top of the wealth distribution usually have the most income. (Norris, 2010) stated that most of the rich people’s income does not come from working. He explained that in the year 2008, only 19% of the income reported by the 13,480 individuals or families making over 10 million dollars came from wages and salaries.
First of all, the writer of Reader’s Digest, (Crowley, 2005) has displayed precious little knowledge of economics, and at times his complaints were also downright contradictory. So, his article begins with the anecdote about Stephan Crawford and also then the co-president of Morgan Stanley. He stated that Crawford quit during a “management shake-up” and then “strolled off” with a severance package that included his two year’s salary and also bonus where all of them amounted to 32 million dollars just a few months after accepting a promotion from the company.
Then Crowley pointed out that “Crawford pulled in 54,000 dollars per hour into his pocket! ” which is a huge amount of money in order to make sure that his readers are sufficiently outraged. (Murphy, 2006) then explained that if a person wants to show how much more the CEOs get paid, and of course all of them do get paid far, far more than some other average workers that work in the companies, then a fairer comparison would have been the mean annual earnings of the average workers versus the mean annual earnings of the CEOs.
Then later (Crowley, 2005) came out with a report by following this more reasonable route and reported that in the year of 2003, CEOs were paid over 300 times what the average production worker made. (Murphy, 2006) also gave an example like Crawford rigs the comparison by saying that one could certainly find some cases of average Joes who quit or were laid off after working for a very short period of time, and hence whose “hourly earnings” would appear vastly inflated.
So using Crowley’s approach, (Murphy, 2006) argued and showed that some Irish workers are paid six times more per hour than the median temp worker. Even on its very own term, the calculation is kind of suspect because Crowley isn’t explicit about where the 54,000 dollars per hour figure comes from, but we do know that the total package was 32 million dollars and that Crawford quit about 100 days after starting in the new spot. (Murphy, 2006) also said that 32 million dollars divided by 100 is 320,000 dollars per day, which works out to 40,000 dollars per hour if we assume eight hours of work per day.
So in order to get higher figure of 54,000 dollars, he said that Crowley must be assuming that, in addiction to work only eight hours per day, Crowford only worked five days per week in his company. Of course, these minor quibbles about the figure overlook the biggest objection, so what if CEOs do earn more money than most other workers do? (Murphy, 2006) said that in the free market, the price of the corresponds to its marginal product and the competition is to ensure that workers are being paid according to how much additional revenue they bring in to their employer and the companies.
He also explained in further that the fact that some types of labour command thousands of times more market value is no more surprising or outrageous than the fact where some goods in the marketplace (such as house and others) have a price hundreds of thousands of times higher than the prices of other goods (such as a pack of gum). But then, he said it is the critics of capitalism who implicitly claim that the market value should have been correspond to the ethical worth.
However, there is no competent economist that would argue that Stephan Crawford was a good person because he eraned so much money to the company. So he said there really isn’t an issue of fairness subjects to the complication noted above. (Domhoff, 2005) stated that another way that income can be used as a power indicator is by comparing average CEO annual pay to average worker pay, which has been done for so many years by Business Week and also later the Associated Press.
The ratio of CEO pay to factory worker pay rose from 42:1 in 1960 to as high as 531:1 in 2000, at the height of the stock market bubble, when CEOs were cashing in big stock options. It was at 411:1 in 2005 and 344:1 in 2007, according to research by United for a Fair Economy. By way of comparison, the same ratio is about 25:1 in Europe. The changes in the American ratio from 1960 to 2007 are displayed in Figure 1, which is based on data from several hundred of the largest corporations. Figure 1: CEOs’ pay as a multiple of the average worker’s pay, 1960-2007
Then (Domhoff, 2005) said that it’s even more revealing to compare the actual rates of increase of the salaries of CEOs and ordinary workers; from 1990 to 2005, CEOs’ pay increased almost 300% (adjusted for inflation), while production workers gained a scant 4. 3%. He also explained that the purchasing power of the federal minimum wage actually declined by 9. 3%, when inflation is taken into account and these startling results are illustrated in Figure 2. Figure 2: CEOs’ average pay, production workers’ average pay, he S&P 500 Index,corporate profits, and the federal minimum wage, 1990-2005| | Then, in a 2008 paper, New York University economists, (Gabaix and Landier, 2008) stated that the sixfold increase of U. S. CEO pay between 1980 and 2003 can be fully attributed to the sixfold increase in capitalization of large companies during that period and he also said that this suggests the market for CEO works really well ad there are only a few examples of the executives getting paid more than you would expect based on their contributions to the company’s success.
However, the late University of Chicago labour economist, (Rosen, 2009) described as one in which “relatively small numbers of people earn enormous amounts of money and dominate the activities in which they engaged so (Gabaix and Landier, 2008) argued that the differences in talent levels among those top executives is quite small. Then they also stated that those small differences can lead to big gaps in compensation and are magnified by the firm size.
Besides that, in their paper which they worked on, they noted that the first CEO on the list actually earns over 500 percent than the 250th ranked executive which is a very huge gap. Later then, (Crowley, 2005) raised concerns which may trouble even a genuine supporter of the free market. It makes sense that successful corporate executives earn millions of dollars, but he gives us some allegedly outrages examples of this trend by saying that the CEO of Viacom, Sumner Redstone, took home about 28 million dollars including a bonus of 16. million dollars, even though his company’s stock had dropped 11 percent during the fiscal year. Then he also gives some other examples like Mike Splinter, the CEO of Applied Materials, got a tidy 5 million dollars bonus in 2004, despite a stock slide of more than 22 percent which was kind of a huge number of percentages. Then the same year, CEO of General Motors, Rick Wagoner, saw his stock plunge 25 percent and yet he still got a 2. 5 million bonus into his pocket where it was only slightly a bit less than his award in 2003 when GM stock actually rose. Murphy, 2006) said that there is an obvious difference in this respect between the assembly-line workers (or janitors and receptionists) and CEOs. He also said that far more so than all these other employees, the CEO can greatly influence the profitability of the company. He summed up saying that yet this difference does show up quite clearly in the market that CEOs and the other executives do get paid according to how well the company does or how well they run the company because after all, CEOs are brought in to run the company.
He also stated that in addition to their base salaries, these executives are often paid in stock options which give its owner the right to purchase shares of stock at the specific price, called the strike price. Given his outrage over executives being paid regardless of profitability, (Crowley, 2005) also complains about the fairness of this too, even the highly successful companies. He mentioned that the CEO of Yahoo! , Terry Semel, who took advantage of 230 million dollars in stock options in the year 2004. He said that Yahoo!
CEO Terry Semel exercised 230 million dollars in options last year and his company has had strong earnings of late so it is fair for Semel to earn his 600,000 dollars salary, plus a hefty award for boosting the stock price. However, 230 million dollars? Come on, won’t it be too much? However, (Kaplan, 2007) argued that there can be absolutely no doubt that the typical CEO in the United States is paid for performance. Then he also suggested that albeit both times with some hesitation, that CEOs may not be overpaid but in fact, may be underpaid.
Then responding to the concerns about self-aggrandizing boardroom practices, he also argued that corporate governance systems or board have performed better in their monitoring role which is from the year 1998 to 2005 than any previous period. When it comes to the question are CEOs paid based on performance, he said yes and then built his case around Exhibit 13 I his testimony (see Figure 3). The figure above is taken from his testimony (Kaplan, 2007) and this compelling evidence is to show a strong linear relationship between a firm’s stock market performance and CEO compensation.
Then compelling as what it seems, that exhibit obscures as much as it reveals. (Kaplan and Rauh, 2007) then rank-ordered all the CEOs in the ExecuComp database by their firms’ size for each year between the year 1999 and 2004. They cut those annual profiles into deciles and they looked at the “actual” compensation amounts for these CEOs and rank-ordered the results at that point. Then they created the deciles of compensation within each size decile. Therefore, Figure 3 captures the relationship between those compensation levels and the firms’ ndustry-adjusted stock price performance in the previous five-year time periods, aggregated over the ten size deciles and the five years of compensation observation. However, (Walsh, 2008) objected Kaplan testimony by saying that the analysis raises three questions that warrant some scrutiny (especially when it is so authoritatively offered in the public square). He stated that firstly, the measure of performance such as adjusted historical stock performance, collected over a long, idiosyncratic and time period is just one of the many ways to assess firm performance.
He said given that there are other measures and other time to assess and why did they choose this measure? Then secondly, he asked were the CEOs in office during those historical five and three-year performance windows and we do not know if they were paid for their own or their predecessor’s performance. And then third, he asked why did Kaplan and Rauh decide to exclude options that were granted in the year of observation? He said that this is not the customary practice in this literature and also stated that Kaplan’s empirical approach deserves as much explanation as do his results.
He then came out with a histogram and this histogram reveals a fact about CEO compensation that Kaplan’s histogram does not where Kaplan’s figure does not tell us how much the CEOs made. Figure 4 CEO Compensation and Firm Performance (2005) (Walsh, 2008) stated that the CEOs in each decile earned between 4. 2 million dollars and 16. 3 million dollars. The CEOs in the bottom decile which is a decile marked by very poor firm performance still made more than 4 million dollars.
Then he explained that if we perform a median split on firm performance and compare the total compensation for those in the top half of the performance distribution with those in the bottom half, we see that those on the top earned an average of 11. 2 million dollars. Meanwhile those on the bottom half earned 8. 1 million dollars. (Kaplan, 2007) concludes that there can be absolutely no doubt that the typical CEO in the United States is paid for performance. However, (Walsh, 2008) objected and supposed that we should focus on the word “typical”.
He said that the 676 CEOs in the first, second, third, and fourth performance deciles, for example those CEOs who made on average 4. 2 million dollars, 7. 2 million dollars, 8. 6 million dollars, and 12. 4 million dollars respectively, may not be “typical” U. S. CEOs in his mind. Then arguing that the CEO job is becoming increasingly difficult and less pleasant and then noting that hedge fund and private equity managers, venture capital investors, investment bankers, professional athletes, and lawyers can also earn lots of money.
However (Kaplan, 2007) said that CEOs are not overpaid, instead they are underpaid. (Chait, 2007) claimed that the reason the reason for the bill is that there is an abundance of evidence that CEOs get paid too much. He said not too much in the “why do teachers earn 35,000 dollars a year while the CEOs earn five hundred times as much” sense, but too much in the sense that their compensation actually doesn’t reflect their actual economic value.
He then said that in 1976, the average CEO compensation was 36 times that of the average worker in the company, and then it was 369 times more than the worker average in 2005. So the rise in CEO pay vastly exceeds the rise in value of the companies they run. Then he said that there’s an alternate theory explaining the explosive rise in CEO pay. It also holds that the boards of directors, which set CEO pay, don’t perfectly represent shareholder interests and board members are sometimes appointed by CEOs or are CEOs themselves.
Their incentive to please the CEO by keeping his compensation high is greater than their incentive to please shareholders by keeping it low. He then said indeed, being too tough on a CEO could jeopardize their chances of getting future appointments. He also stated that above all, board members are social beings, not perfectly rational maximizers of investor utility and they often belong to multiple boards and don’t expend much time bargaining down CEO pay on behalf of shareholders. They identify with the CEO and will go along with overly generous pay unless it’s so huge and it provokes outrage.
Besides that, their standard method is to set pay by looking at the industry average and going a little higher where everyone wants to think their executive is above-average. The result is a cycle of ever-rising CEO pay. Then, (Bedchuck and Fried, 2007) have found out a lot of evidence to support this theory. They have looked at all the factors where one would actually associate with a weak board of directors where the CEO is a director of the board, or a member, or even the members serve on several boards and all of them correlate with higher CEO pay.
Then they claimed that the discovery that executive compensation is dependent not just on supply and demand but on the independence of the board of directors helps explain a lot of facts that the pure free-market model can’t unnecessarily complicated pay schemes, bonuses to fired executives who were owed nothing, and so forth. They said that this theory is the basis for the House bill giving shareholders the right to a vote on executive pay and a nonbinding vote would give shareholders a chance to express dissatisfaction with exorbitant pay and shame compensation boards into doing their jobs.
Then for example, Great Britain and Australia have this arrangement, and it has curtailed the worst abuses. However, Republicans, though warn that letting the shareholders hold even a symbolic vote would have all sorts of dangerous effects. A University of Chicago professor, (Kaplan, 2007) stated that the regulation, criticism, and hounding of public-company CEOs may have a major cost from a testifying at a hearing two months ago. He also said that CEOs can and will leave public companies to do something else. Then (Chait, 2007) said that the poor dears.
The average CEO of a Standard & Poor 500 company earns nearly 15 million dollars a year and this would make it worthwhile to suffer perhaps some very occasional criticism from the people who pay their salaries. He also said that, but apparently beneath the image of the hard-charging chief executive lie some very delicate flowers. Then he summed up saying that Fellow Republican Mike Castle of Delaware, whose management-friendly bylaws have lured more than half of all public companies to incorporate there, worries that “activist institutional investors, who may have their own political and social agendas” would get “more influence. Besides, GOP Representative Randy Neugebauer warns that “this impulsive legislation can only distract shareholders from their true power which is the power to pull their investment from any of the company that acts recklessly in deciding the executive compensation. ” In sum, he also said that investors are hippie freaks and as distractible as small children. Then he said the funny thing is, conservatives usually glorify investors or, in their creepy Marxist phrase, “the investor class. ” It’s not unusual for them to straightforwardly pledge to advance the interests of this favored class. Bush recognizes that the investor class is the most important demographic group in the country,” (Norquis, 2003) said that during celebrating tax cuts for stockholders. (Walsh, 2008) also stated that it may reveal why executive pay feels so outrageous to so many and why it attracts the Congressional attention it does. Then Parade magazine, the Sunday news magazine with a readership of 71 million people, issued its annual report titled “What People Earn” on April 13, 2008. Besides that, the article opened by noting that today’s median U. S. salary is $36,140 and then followed with the provocative question “How does your salary stack up? Next, a profile of more than 100 individuals from all walks of life gave readers a type of barometer and each one of them was pictured, along with his or her name, age, occupation, and city of residence. CEOs of two publicly traded firms were among the list. Kerry Killinger, 58, the CEO of Washington Mutual, earns $5. 25 million and was pictured between Kim Leisure, a 41-year-old payroll administrator from Ocoee, Florida, and Sue Gage, a 52-year-old janitor from Shelby Township, Michigan. Kim and Sue earn $41,000 and $10,700, respectively.
James McNerney, 58, the CEO of Boeing, earns $19 million, while Mitch Carmody, the 53-year-old church facilities manager in Hastings, Minnesota, pictured right below him, earns $42,000. Complications of pay notwithstanding, (Walsh, 2008) also said that these juxtapositions leave many people angry. He said he is not suggesting that Parade’s approach is in any way scientific, but the article and others like it in the mainstream press certainly raise questions for readers about the fairness of CEO pay practices. Academic arguments must be attuned to questions of legitimacy, especially if scholars seek to challenge conventional thinking.
Then concerns with executive pay have as much to do with the standing and credibility of business, measured relative to our accepted norms of fairness, as they do with the nature of the link between pay and economic performance. (Camerer, 2003) said that economists tell us that these norms are no less important than economic gains It is just as important for CEO pay to be seen as legitimate by the people in Ocoee, Florida, and Hastings, Minnesota, as by Wall Street’s bankers and lawyers—and those who care about Wall Street’s bankers and lawyers.
Then, (Kaplan, 2007) refers to CEOs as “fortunate and talented” numerous times in his testimony as he uses the word “fortunate” seven times in the AMP essay, three times in the phrase “fortunate and talented”. There are many talented people in this world who earn far less than Mr. Killinger and Mr. McNerney. The key word here seems to be fortunate. While (Kaplan, 2007) will not say that these CEOs are overpaid, he does admit that these individuals are very fortunate to take home millions of dollars each year in a nation where the median worker brings home less than $40,000.
Besides that, the legitimacy of executive pay is also called into question when good fortune plays such a role in our understanding of it. If we want to consider the legitimacy of CEO pay, it is the opinions of Parade magazine’s 71 million readers that do really count. Then Joe Bageant’s (2007) sobering book, Deer Hunting With Jesus: Dispatches from America’s Class War, which gives us a look at the lives of people who may cast a jaundiced eye on these compensation practices and any effort to defend them. Walsh, 2008) also said that perhaps even a University of Chicago business school professor might question the legitimacy of contemporary CEO compensation practices after reading this book. While scholars must be willing to challenge accepted thinking, it is also true that our work ought to grasp the underpinnings of that accepted thinking and public concern about executive pay is not about the nature of pay/performance sensitivities, nor is it about envy. The concern is about all about fairness.
Taken-for-granted norms of fairness are essential to the health of the free market system and they too need to serve as a reference point for assessing CEO pay. Then, quietly aware of the “Bebchuk critique” in his testimony and the explicitly aware of it in his AMP paper, (Kaplan, 2007) also asked that if powerful CEOs corrupt the compensation-setting process and he also asked what boards do and if their work is compromised by the CEOs. Then he shared results from two of his working paper before answering those questions before Congress.
Besides, he said if we see evidence that CEO pay is tied to performance and that CEOs are dismissed for poor performance, he argued, then all is well in the boardroom. Then with respect to the dismissal question, we learn that the CEO turnover rate in the 1970s, 1980s, and 1990s (through 1997) was 10% per year and then he reports that the rate increased to 12. 8% in the 1998–2005 time period. He views that jump as “substantial” and offers it as evidence of admirable board discipline. So can we take comfort in knowing that CEOs are now more likely to be fired for poor performance? Walsh ,2008) said he doesn’t think so because those 10% and 12. 8% figures account for retirements, deaths, and voluntary departures of all kinds, as well as any performance-induced involuntary turnover. Given how difficult it was to be fired for poor performance in the 1970s and 1980s, he also said that he doubts that a 2. 8% increase is meaningful. Then look at the evidence for CEO discipline back when the annual turnover rate was 10% and Gilson (1989) examined the dismissal patterns for two groups of CEOs who led 381 firms in the bottom 5% of the NYSE and AMEX for three consecutive years in the year of 1979–1984 period.
One group led these bottom-dwelling firms absent any other extraordinary signs of distress; the other group led these same bottom-dwelling firms but their firms also defaulted on their debt obligations, restructured their debt outside of bankruptcy, or went into bankruptcy. He found that neither group of CEOs was necessarily destined to lose their jobs and only 19% of companies in the first group changed their CEO, while 52% of the firms in the second group of even more distressed firms did so.
Gilson then showed us that CEOs who preside over three straight years of abysmal performance and lead their firms into default or bankruptcy faced only a 50-50 chance of losing their jobs back then. That is the kind of board discipline that was associated with a 10% annual turnover rate. (Walsh, 2008) said that he wonders how much more exacting our management discipline is today now that the base rate of dismissal inched up a few notches to 12. 8%. He said that the CEO’s job is not as contingent upon performance as Professor Kaplan implies.
Meanwhile, the Gilson (1989) study is just one of hundreds of studies of corporate governance practices. Furthermore, Shleifer and Vishny (1997) and, most recently, Dalton, Hitt, Certo, and Dalton (2007) did also provided comprehensive reviews of this research. Therefore, there is also a huge literature on executive compensation, and comprehensive reviews of it (Devers, Cannella, Reilly, & Yoder, 2008; Murphy, 1999, 2002; Tosi, Werner, Katz, & Gomez-Mejia, 2000). Kaplan, 2007) also knows that CEO compensation practices have come under a sophisticated and withering attack in recent years. Bebchuk and his colleagues led the assault (Bebchuk & Fried, 2003, 2004, 2005a, 2005b; Bebchuk, Fried, & Walker, 2002). While contemporary CEO compensation practices have their spirited defenders (Core, Guay, & Larcker, 2003; Core, Guay, & Thomas, 2005), therefore (Walsh, 2008) said that he wonders why Professor Kaplan ignored his evidence when he prepared his Congressional testimony. He said that his oversight leads him to wonder about the responsibilities of the business scholar to society. Next is a quote from a Reuter’s article says that China, for example boasts three of the world’s four largest banks and yet the leaders of the banks such as Industrial and Commercial Bank of China, China Construction Bank Corp and Bank of China are among the lowest paid of those surveyed by Reuters.
The chairman and the president of the banks are paid roughly about 230,000 dollars per year. However, here in Malaysia, the SYABAS CEO, Rozali Ismail went on record as to admitting that his salary is RM5. 1 million per year and if we convert his salary into US Dollars, it will come up to roughly about USD 1. 6 million. So in other words, the CEO of Syabas makes USD1. 33 million more in one year compared to the CEO of bank of China.
Besides that, the users have also been posting some comments about the salary of Syabas CEO saying that he earns RM425, 000 a month which is 19 times more than the salary of the prime minister at RM22, 826. 65 a month in this country. Next, in a May 2009 paper, Gabaix and three co-authors propose one possible solution for improving incentive structures where they suggest awarding executive pay through “dynamic incentive accounts. ” Under the plan, CEOs would see their pay escrowed each year and they would have no immediate access to most of it.
A constant percentage of the executive’s pay would be invested in the company stock and the remainder in cash and then the portfolio would be continuously rebalanced so that the portion of company stock is sufficient to induce effort at minimum risk to the executive. Besides that, the executive would receive small portions of the account gradually, and that gradual vesting would continue even after an executive’s departure. Therefore, they said this could discourage an executive from behaving badly, such as using accounting tricks to inflate the company’s short-run stock price before cashing out and leaving the firm in shambles.
CONCLUSION In the end, we must accept that in the modern economy, with billions of potential consumers worldwide, certain individuals have extraordinary earning power on the open market. If someone like Semel, the CEO of Yahoo! (or, a stronger case, Bill Gates) can add hundreds of millions of dollars of value to an organization (as judged by the spending habits of consumers), then to not pay him accordingly just means that someone else gets the money.
Besides that, the CEO is the one who responsible for the success or failure of the company such as operations, marketing, strategy, financing, creation of company culture, human resources, hiring, firing, compliance with safety regulations, sales, PR, and so forth and it all falls on the CEO’s shoulders. I believe they are paid too much but then again they do a lot in order to keep the company together. Therefore, if they did a really good job and brought good earnings to the company, they do deserve to get a higher salary somehow the money they got should be worth the performance they did.
But then when people always argued that why we want to hire a foreign CEO from other countries to run those companies in our country, I would say that if that particular CEO from foreign country has got the ability and potential to run the company and bring the company to a higher level of earnings and all, then he/she should be hired without considering whether the CEO is a foreigner or local because when the CEO is capable to run the company and bring great earnings, the company itself does get advantages from that so why not paying them a high salary based on their performance and how well they did.
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