Text book is : Fundamentals of Human Resource Management
Robert N. Lussier; John R. Hendon
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CASE 13.1 CEO COMPENSATION: DO THEY DESERVE ROCK STAR PAY?
It really does pay to be a CEO of a Fortune 500 firm, according to the AFL-CIO. The average S&P 500 chief executive made $13.1 million in 2016, 347 times more than the average U.S. worker did, up from 335 times as much in the previous year. For this study, the AFL-CIO analyzed available filings from 419 companies in the S&P 500 index. It found the average pay of these CEOs was roughly $13.1 million in 2016, a 6% increase over the prior year. In contrast, the average annual pay of production and non-supervisory workers in the United States was $37,632, a 2% increase, the labor group said, citing figures from the Bureau of Labor Statistics, a Department of Labor agency. The AFL-CIO said that when adjusted for inflation, U.S. workers’ wages have been stagnant for 50 years. Adjusted for inflation, production and non-supervisory workers averaged $41,473 a year in 1967, for instance.
The widening pay gap reflects a growing income inequality, according to the AFL-CIO, the largest federation of U.S. labor unions, which posted the latest figure on its website. The group used the survey release to highlight slow U.S. wage growth and the outsourcing of jobs to countries with lower wages. The labor group’s annual study often draws notice as a measure of how U.S. workers largely are not sharing the economic gains of those at the top of the income scale, even as official unemployment remains at near all-time lows.
Why such a high salary given the fact that the U.S. economy has grown (at most) 2% per year over the past few years, one third of the growth of CEO salaries? U.S. CEO pay is often high because of the widespread practice of using “peer group” averages to set pay, AFL-CIO officials said in a conference call with reporters. One improvement could be to make shareholder votes on pay binding, as they are for British companies, they said. Yet, at the same time, U.S. investors do not seem upset with the situation. In the advisory votes that S&P 500 companies held for their shareholders on executive pay last year, they received average support of 91%, according to consulting firm Semler Brossy. Only six companies received less than 50% support in the advisory votes.132
The public certainly feels that CEOs are overpaid. In 2016 the Rock Center for Corporate Governance at Stanford University conducted a nationwide survey of 1,202 individuals—representative by gender, race, age, political affiliation, household income, and state residence—to understand public perception of CEO pay levels among the 500 largest publicly traded corporations. Key takeaways are that, according to most Americans, CEOs are vastly overpaid, most Americans support drastic reductions, yet the public is divided on government intervention.
Among those polled, 74% believe that CEOs are not paid the correct amount relative to the average worker while 16% believe that they are. Although responses vary across demographic groups (e.g., political affiliation and household income), overall sentiment regarding CEO pay remains highly negative. “There is a clear sense among the American public that CEOs are taking home much more in compensation than they deserve,” says Professor David F. Larcker of Stanford Graduate School of Business. “While we find that members of the public are not particularly knowledgeable about how much CEOs actually make in annual pay, there is a general sense of outrage fueled in part by the political environment.”
Nearly two thirds (62%) of Americans believe that there is a maximum amount that CEOs should be paid relative to the average worker, regardless of the company and its performance. Interestingly, a majority of all political groups believe CEO pay should be capped in some manner, although Republicans are somewhat less likely to hold this opinion (52%) than are Democrats (66%) or Independents (64%). Those who believe in capping CEO pay relative to the average worker would do so at a very low multiple. The typical American would limit CEO pay to no more than 6 times that of the average worker. These figures are significantly below current pay multiples.
Those who favor government intervention support a range of possible actions, although none alone receives majority or even close to near-majority support. Among respondents who advocate government intervention, 28% would substantially increase taxes on CEO compensation above a certain amount, 25% would set a strict limit on the dollar amount a CEO can receive relative to the average worker, and 17% would limit the absolute dollar amount that a CEO can receive. Furthermore, 17% would require more performance-based compensation, 9% would ban the use of stock options in executive compensation contracts, and 8% would ban the use of all equity compensation in CEO pay packages.133
However, many experts do not agree with the public and would argue the public does not have all of the facts. Jannice Koors, managing director of Pearl Meyer & Partners in Chicago, has a different perspective on CEO compensation.
I think most companies are on the right track with their [executive] pay programs. Yes, CEO pay increased this year—because average company profits and share prices grew. Compensation is more closely tied to performance than ever before, which is exactly what shareholders have been pushing for. Today, only a very small percentage of a typical CEO pay package is in the form of a guaranteed annual salary.134
Donald Delves, director of Towers Watson in Chicago, justifies CEO pay this way:
CEOs are paid about three times as much as the next level of executives…. In my experience, it is a very rare person who has the skills and experience required to run a huge global corporation. And their average tenure continues to decline. There is not a lot of patience shown by shareholders and boards when a company underperforms.135
Anthony Smith, author of The Taboos of Leadership, noted,
The reality is that the free market is alive and well, and is the true dictator of CEO pay. While what one’s peers are making is still a legitimate barometer, critics should look at the macroeconomics of “stars” in all fields (after all, CEOs are the “stars” of the business world), and not just the micro economics of CEO pay, if they are serious about understanding the calculus in determining compensation. Such valuation analysis must factor in the track record of the CEO; his or her potential; competing job offers; personal enticements; what he or she is leaving behind; their reputation on the “street”; and the team of other executives he or she is likely to bring or attract…. only a handful of people are capable of leading major multinational corporations with 100,000+ employees and $50+ billion in annual revenue. Bottom line: true stars are in short supply and high demand. It’s pure Economics 101.136
Whether you agree or disagree with the fairness of CEO pay, CEOs make as much in 1 day as the average worker makes in 1 year.
Questions
How does ethics apply to this case?
What factors might contribute to what some perceive as unethical behavior concerning CEO pay?
What are the differing ethical approaches, and how might they apply to this case?
How might the issue of CEO compensation be dealt with in a firm’s code of ethics?
How might the issue of CEO compensation be used by a firm to create and maintain an ethical organization?
What is your own opinion about CEO compensation? Provide facts and arguments supporting your position from this case.
Case created by Herbert Sherman, PhD, and Theodore Vallas, Department of Management Sciences, School of Business Brooklyn Campus, Long Island University
