A controversial business ethics issue that has been a debate for over a decade now is concerned with executive versus employee compensations. Since the 1960s, corporate executive compensation is at its highest level and continues to grow, while the average salary worker remains stagnant or has increased at a slower and lower rate. According to The Economic Policy Institute, CEO compensation grew by 937% between 1978 and 2013, in comparison to 10.2% for an average employee’s compensation (Mishel and Davis 2014). In 1965, the United States recorded the average CEO to worker ratio as 20 to 1, compared to 295.9 to 1 in 2013 (Mishel and Davis 2014). The increasingly wide margin between the two compensations has essentially contributed to the profound levels of income inequality. An executive compensation packages include benefits such as, bonuses, stock options, pensions, performance metrics, claw back provisions, and golden parachutes.
The main purpose of executive compensation is to create an incentive to align the goals of executive and shareholders, which is to essentially increase productivity and maximize the firm’s value. Compensation packages also encourages executives to engage in risky and profit-maximizing activities because it could potentially produce highly profitable returns; thus, benefiting the shareholders. Without these immense compensation packages, there could be a conflict of interest between the executives and shareholders. Executives may pursue personal goals and focus on their own wealth at the expense of the corporations’ shareholders.
There are several arguments in defense of the current executive compensation packages. One argument for the compensation packages is that it should be merited based. The individual has been rewarded for his or her hard work and has essentially earned their compensation. This is extremely necessary to attract the best candidates. There are industries such as the sports, arts, and entertainment where certain individuals earn beyond the average pay. The reasoning is to allow these individuals to charge more for their competitive success, talent, and positive performance.
A second point is related to the idea of pay for performance. There seems to be a positive correlation between bonuses and stock options and corporate profitability. As benefits increased or decreased, the firm seems to experience significant gains or losses in profitability, as well. High equity compensations incentives executives to focus on earning profits for the company since it could either benefit or affect their standing.
A third argument is that the current levels of compensation packages are according to market rates. An executive position has economic value and the price to fill the position is based on supply and demand. If there is a high demand, the price will increase and if the supply increase, the value will decrease. Filling an executive position is not easy, therefore there is a high demand and low supply. This position requires an individual with a certain set of knowledge, skill, and experience of a particular industry. With this high demand for talented individuals, firms began to offer generous compensation packages to keep the talent within their firm.
In contrast, there are several critiques to the current level of executive compensation. The first argument is that with stock options being a large proportion of executive compensation, executives are now encouraged to focus on short term investments to ensure high return on earnings. Profit sharing is calculated based on ROI; therefore, executives would want to pursue investments or activities that produces high profits to receive a greater return for themselves. Focusing on short term profitability can result in excessive risk taking and unethical behavior. Executives will go to the extent of manipulation of short term financial information and engage in unethical practices, which could potentially lead to the manipulation of financial statements. The maximization of short term profitability can be unethical and be detrimental to long term growth and sustainability.
Another critique of the current system is that the aim of short term wealth can result in excessive greed. Executives are primarily focused on maximizing profits, and they will go through great lengths to satisfy shareholders and themselves. It is a continuous cycle of engaging in unethical activities and feeling a sense of high from the extreme returns. After receiving a high return, executives’ next target profit will be greater than the previous one. The amount to executives will aim for is unimaginable, and the craving to earn more and more is endless. The seeds of greed are planted into their hearts.
A third critique is the idea of golden parachutes. Golden parachutes benefits CEO’s given that if a merger occurs, they will be well compensated once he or she is terminated. In addition, they are designed so that unsuccessful ventures or investments can still result in a generous payout amount. The average golden parachute for CEO’s forced out of their jobs is $48 million. This raises anger among the public because they argue that executives are already well-compensated, and therefore don’t need to be rewarded for being terminated. Similar to a golden parachute, golden handshake is offers a severance package to executives when he or she becomes unemployed.
A fourth argument against the existing system is that it demoralizes lower paid employees. For certain industries, the difference between CEO or executive pay compared to the average employee is staggering. For instance, in 2015 the CEO of McDonalds received a performance bonus for $23 million, while the employees earned $7.25 per hour. Employees in the fast food industry typically work full time or balance more than one job to meet their financial needs. Thus, this scenario can be perceived as demoralizing for a CEO to walk away with such a large payout, meanwhile his employees are barely scrapping by to pay for rent, clean clothes, food, or perhaps even survive. One can imagine how the scenario can be worse if the company isn’t performing well and yet, the CEO or executive is still benefiting.
A fifth critique concerns the link between the current system and social inequality. It is evident there is a direct influence in the current compensations of executives and employees to the growing gap in income inequality between the two parties. With the combination of the drastic difference in wages, compensation packages in the form of equity, lower tax rates, and tax loopholes, executives continue to take home a greater income in comparison to an average American.
In response, I have created a proposal for potential solutions. One solution is for government to impose a higher minimum wage. A raise in a minimum wage would help reduce the pay gap between upper management and employees. By increasing the pay, employees will no longer have to be anxious about meeting their financial needs or providing a meal on the table for their family. Raising the wage will help create stability and produce many advantages within the middle and lower class families. Kids can grow up in a positive environment, receive a proper education, have access to good quality clothes and food, and essentially, have the opportunity to flourish and be introduced to more opportunities in the future. As the livelihood of employees improve so does the enhancement of our community and ultimately, the company.
A second solution could be to impose higher taxes the wealthy. For decades, as income increases, tax rate increase in proportion. However, the system has grown to become corrupt in that the wealthiest Americans pay a lower tax rate than an average family. According to an article, in the 1950s and 1960s, the income tax rate for the wealthiest Americans was 91%. Today, the top 1% pay a maximum tax rate of 43.4%. Data has shown that 30% of income inequality is due to unfair taxes and budget cuts. Changes in income in the form of capital gains and dividends has been one of the largest contributor to increasing income inequality. Government should focus on increasing tax rates on the wealthy rather than cutting education budgets or Social Security and Medicare. There are so many different tax loopholes such as unearned income, inheritance taxes, payroll tax for S corporations, and etc.
A third solution is to invest in the bottom of the corporate chain. Based on a Stanford Social Review by Jody Hemann, she discovered that when companies invest in their lowest level employees are more productive and more profitable. A company should consider adopting one or more of the following five approaches: to provide incentives so that everyone in firm benefit when the firm succeeds, engage line workers and act on their best recommendations, support the health of all their employees, provide training and career advancement opportunities, and recognize the communities in which companies are located need benefit from the company. When a company enforces these approaches, offer better benefits, working conditions, and increase pay, the employees can prosper.
Executive compensation is an undeniable ethical dilemma in today’s business world. As the new generation of executives rises, one could assume that the compensation packages will continue to increase, as well. New generations will demand a higher and better package, which will increase the income inequality gap and hurt the rest of the middle and lower class Americans. It could also lead to more unethical business practices, rooted excessive greed, and more tax loopholes. Brittany Silvey from the University of Northern Iowa suggests that the root of this problem lies with individuals’ virtues and morals. One’s environment in which we are affiliated with has a huge impact on the thing one values and the virtues we cultivate.
Perhaps, the issues we are dealing with will require for a societal change, that is a society that places a greater emphasis on “community, cooperation, and teamwork rather than immense emphasis given to individualism.” This controversial topic has been a target of discussion for over a decade and it is no surprise that we will resolve the issue overnight or over the next several years. First and foremost, it is important that Americans view this as an ethical issue. An issue can not be solved if one does not recognize the issue to begin with. Secondly, it is important to acknowledge and applaud the steps and efforts Americans take in order to solve the issue regardless of how large or small. Any step towards our ultimate goal is worth rewarding. Perfect should not be the enemy of good.
