Why Are US Executives Overpaid?
When the financial crisis started to hit the United States in the last two quarters of 2008, millions of jobs were lost - Why Are US Executives Overpaid? introduction. The ballooning executive compensation packages were believed to be the one of the reasons of the bankruptcy or close to bankruptcy situations of a number of US companies. The executives have justified their compensation based on the criteria of “pay for performance” and on the nature and complexities of business, wherein greater demand for excellent and skilled managers means greater pay.
Surprisingly, the firms who were recipient to the federal government’s Troubled Asset Relief Program (TARP) to help prevent their collapse were the ones giving out high compensation packages to their executives. This term paper will discuss the situation of compensation scheme, relating the inquiry why are the US executives overpaid. The review of several literatures and data will be the method used in examination and findings. Literature Review The “pay for performance” ties the executive compensation packages on the financial success of the company.
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This is on the belief that the success of the company is credited to the talent and skills of the executives. The companies reasoned out that executive compensation packages must be set at competitive levels so that they can attract, motivate and retain high quality executives who would contribute to the company’s goals and objectives and financial success. While compensation packages are fundamental to the creation of the long-term corporate value, it is also important that this compensation package should be reasonable and fair to everybody especially to the shareholders.
Furthermore, many executives have learned the tricks of the game when claiming for the “pay for performance” provision in their employment contract. This can be in the form of stock buyback and channel stuffing (Pizzigati, 2007). Other companies use “earnings per share” or EPS to measure performance. EPS may appear increasing if the company buys back its own shares on the stock market. As a result, fewer shares of the company would be available or outstanding in the market and the company’s EPS will increase but the overall company earnings do not.
Some companies measure performance through sales. The executives can increase sales by giving incentives to retailers who would later on return the products after the executive received his compensation from the ‘increased’ sales of the company. Hence, high company profits or earnings or sales do not justify high executive compensation packages. High executive compensation packages can also be attributed to the bad corporate governance of the companies. The compensation committee, which sets the executive pay, is usually comprised of other executives or their friends and relatives.
Several shareholder-activists have lobbied for the independence of the key board committees namely: the audit, compensation and nominating committees for sound corporate governance practice. The American Federation of Labor and Congress of Industrial Organizations (AFL-CIO), a voluntary union movement of national and international labor in the US have also advocated for an independent chairman of the board (from the management) to further ensure board independence and accountability. The over compensation of executives would result to low morale of employees.
Putting too much of the company’s resources to a few individuals is not justified. A study showed that in 2008 CEO perks increased to 12. 5% to $336,248 or nine times the median salary of a full-time worker (AFL-CIO, 2008). The illustration below shows the “average CEO to average worker pay ratio”: Source: AFL-CIO (2008) In 2008, the CEOs of the Fortune 500 US companies pocketed an average of $15. 2 million in total annual compensation, the top eight of which pocketed over $100 million (Pizzigati, 2007).
Institutional investors and activists have tried to introduce resolutions like the “Say on Pay” proposals or shareholder advisory vote on executive compensation packages to discontinue this kind of practice. Prior to the much publicized issue on executive compensation packages, the US corporate governance arrangements and the US Securities and Exchange Commission (SEC) have failed to give shareholders mechanisms to share their views and influence executive compensation packages.
Public companies in the United Kingdom have been allowing shareholders to vote on the remuneration report which reveals executive compensation packages. The results of the vote are not binding but this empowers the shareholders to give their opinion that could influence executive compensation packages. The top 10 recipients of TARP have collectively paid a total annual compensation of $242 million to their CEOs (AFL-CIO, 2009. These companies would have filed Chapter 11 bankruptcy if not for the tax payer’s money.
The illustration below shows the “CEO Pay at the Top 10 TARP Bailout Recipients”: Source: AFL-CIO (2009) Findings/Data Analysis It is found that the US government tried to limit executive pay particularly to the TARP-recipient companies. The American Recovery and Reinvestment Act of 2009 restricts them to giving executive bonuses to one-third of total compensation and requiring them to submit for shareholder advisory vote their executive compensation plans.
Thus, this leads o greater accountability on the part of the companies, thereby giving shareholders more information on executive compensation packages. Over the years, some major shareholder advisory companies in the US have tried to challenge management on executive compensation packages. In 2006, they have advised large shareholders of Yahoo to withheld votes from the three board members who served on the executive pay committee. The Proxy Governance, Inc. ound out that Yahoo CEO Semel’s compensation was 926 percent above the median paid to CEO of peer companies (Pizzigati, 2007). Conclusion It can be concluded that everybody should get a fair share of the effects of the crisis. It is quite unfair for the employees in the lower rank that they would lose their jobs as one of the Company’s way of curbing the expenses while the executives get higher compensation. Both may have been different in terms of job rank but both may have worked hard and gave their full efforts for the best interests of the Company and its shareholders.