Essay on executive compensation

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Discusses Major Compensation Issues regarding Executive Compensation. Provides Justification for Unreasonable Executive Compensation and Outlines measures for Executive Accountability

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Essay on executive compensation

  1. 1. Assignment: Question 4It has been proposed that HR managers should be more involved with compensationcommittees charged with determining executive pay packages. In light of this argument,argue if executive pay levels are unreasonable. Use examples to illustrate your argument,what measures are available to make executives more accountable? How HR should beinvolved in determining pay levels?The landscape of business and financial markets has evolved over the years. In particular, thesubject of compensation is becoming an issue prevalent across all spectrum of society. Thus, itbeen proposed that Human Resource Managers should be more involved with compensationcommittees charged with determining executive pay packages. For this reason, this essay shalljustify the argument of unreasonable executive pay levels. Secondly, outline the measuresavailable to make executives more accountable to stakeholders. Finally, to state the involvementof HR in determining executive pay, bonuses, perks and so forth.The issue of executive compensation is a very delicate subject with its own intricacies. To beginwith, it is important to understand the basic definition of who is an ‘Executive’ in organizationalcontext. Furthermore, to determine the basis by which these ‘Executive(s)’ are compensated fortheir service. By understanding the background of Executive Compensation then and only, canwe provide support for the unreasonable executive compensation package(s). The term‘Executive’according to Perkins (2009, pg. 149) ‘is someone in an organization’s seniormanagement group employed at corporate level’, more specifically pepper (2006, pg. 5)describes executives as “responsible for defining and executing a company’s strategy, whothrough their actions are capable of directly affecting (positively or negatively) the company’sprofits, share price, reputation, market position and so forth”.The aforementioned definitionestablishes executives as Chief Executive Officers for which this argument will focus on.Furthermore, there are five basic components of executive pay packages as stated by Milkovichet al. (2011), these are; base pay, bonuses, perks, short term bonus and long term incentives. Abase pay is the established minimum salary that an employee receives for his/her designatedposition although the base pay varies according to the position one is designated to. Exorbitantcompensation is largely recorded in CEO’s position, for instance, Milkovich et al (2011) notedthat Robert Iger, the CEO of Disney had total compensation of USD$51 million. The base paydetermined was USD$2 million and with a bonus of USD$14 million. In addition, he also
  2. 2. received a massive USD$34 million in stock options. The second component of compensation isbonus package which exist in the form of indemnity, disability insurance, social security plansand so on, and for this, executives typically receive higher benefit than most other exemptemployees. Furthermore, Perquisites or ‘Perks’ are becoming an evident part of compensation.These perks according to Milkovichet al (2011) are designed to satisfy unique needs andpreferences. For instance, if James Bernhard CEO of the Shaw group dies, his family will receiveperk pays of up to USD$18 million. Equally, William Weldon, CEO of Johnson & Johnson, gotUSD$154,000 of company jet use and USD$26,000 for a car and driver, (Milkovichet al,2011.pg. 485). Another component of compensation is the bonus of executives which areintended to stimulate better short term performance. For instance, American Airline executivewere paid as much as USD$2 million after its shares jumped from USD$1 to USD$20, owingheavily to employee givebacks (Milkovichet al, 2011. Pg.482).finally, long term incentives inthe form of stock options have a built-in incentive for executives to strive for long termsuccess.These components are important as they form the foundation of executive pay.The argument of unreasonable executive compensation is justified on the grounds that certainpayouts does not reflect Pay-on-performance, secondly, to a certain extent it does not mirror theprevailing market value and/or profitability of the organization.Finally, it is most unethical andinequitable in every respect for a single person to receive such payments under current economicelements. Firstly, Pay-on-performance compensation is the linkage of wages to executiveperformance. The idea is, if the company’s executive performance exceeds stakeholders’expectations bonuses and stock payout will consequently follow. However, in recent decademost payouts are done without proper justification; meaning that it is not reflective of theirperformance which in this case is the poor performance of the company. Forexample,EthicsWorld(Anon, 2008)reported that in 2007Countrywide lost $1.6 billion and itsstock lost 80% of its value. Merrill Lynch’s stock lost 45% of its stock worth $10 billion.Citigroup also lost $10 billion and its stock lost 48% of its value. In spite of substantial losses,the CEOs were still remunerated considerable amounts. Accordingly, in the case of MerrillLynch’s stock wipeout its then CEO Stanly O’Neal was reported to have been eligible toUSD$161 million in retirement package. Moreover, in 2007 the companyreportedly paidUSD$15.9 billion of compensation and benefits, exceeding the companys revenue by USD$4.6billion. It is in this regard that such compensation was unreasonable and unsubstantiated and
  3. 3. comes at a time when New York based companies were cutting back on job due to the collapseof the US mortgage market. Secondly, exorbitant compensation may fail to reflect the conditionsof market forces as such presents a degree of unreasonable compensation package. Certainorganizations align their internal pay structure according to competitor’s decisions based on themarket. Milkovichet al (2011) presumed that fairness is echoed by market rates. However, thebone of contention lies in the question of whether an executives pay is truly reflective of thecompany’s market value and/or the profitability of the company. For instance, Intel’s CEO PaulOttelini’s compensation doubled in 2007 and his salary capped at USD$770,000. This is despitethe dramatic drop in Intel’s stock by $9 per share to $25 per share (Milkovichet al, 2011. pg.478). In addition to that, the company’s earnings and market shares have also declined.In light ofthis supporting argument it should be made certain the degree by which compensation provesunreasonable, so that the organization can align its priorities and better reflect value created formoney. Failure to do this can have serious implications to the organizations success. Finally, it ismost unethical and inequitable for executive to be paid so much at the expense of others. This isUnethical in the sense that, executives like the CEO is paid ‘top money’ in the midst of theorganizations restructure plans or downsizing period. An example would be the Pacific BrandsCrisis in Australia that led to the sacking of 1850 Australian workers. According toschermerhorn et al (2011, pp. 55-56), Pacific Brands is an Australian Company thatmanufactures international brands like bonds, berlei, hard yakka, holeproof, firefighters uniformand so forth. Its values as stated in their annual report are flexibility, quality, speed and ‘ethicalresponsibility’. Moreover, schermerhornet al (2011, p. 56) went on to state that the companywas moving its manufacturing plants to china, where cheaper labour is readily available. In themidst of this entire furor, its CEO Sue Morphett’s pay rose from AUD$680,000 to AUD$1.8million but although it does not register in the league of highly paid executive. It nonetheless,sparked outrage among Australians due to the loss of significant number of jobs. In analyzingthis case, the value of ‘ethical responsibility’ has been ignored. There is no way to ascertain thevalidity of her pay increment in light of the sacking of 1850 workers. As such it is argued thatthere was a high degree of unethical responsibility displayed regarding compensation as such,warrants justification of unreasonable compensation awarded to the CEO Sue Morphett.Nevertheless, there are measures which are available to make executives more accountable to thepublic and to its key stakeholder(s). Accountability as a vital element of trust can be addressed
  4. 4. by the organization. To begin with accountability according to the Oxford English Dictionary(2002) is defined as someone who is responsible for or required to account for ones’ conduct. Itis simply referring to someone in a position where he/she is answerable to a group of people.Since executives like the CEO’s are involved in the strategic planning and direction of thecompany. They must fully disclose the details of company’s expenditure and justify provision ofCompensation so that the company’s stakeholders are fully aware on how their money is spent.The disclosure of organizations operational, financial and quality performance as Robert andConners (1998) put it; can be achieved through, town meetings, focus groups and use of themedia to disseminate important updates regarding projects that the organization has or isplanning to undertake. Secondly, the composition of board executives should reflect arepresentation of the diversity of the social, political, gender, age, and economic background ofpeople so that a balanced community-wide perspective is considered during the decision-makingprocess. Thirdly, the implementation of ‘Clawbacks’ provision, which requires executives to payback excessive incentive pay in the event of an accounting restatement, where more recentlyboard executives are trying to prevent fraud and other accounting errors by tying pay toperformance (DeHann, E. et al,2011). Accordingly, DeHann et al (2011) concluded in theiranalysis of 300 firms that Clawbacks develop the accuracy of financial statements and increaseinvestor trust. Any accounting misstatement intentional or not sends a firm’s stock pricetumbling and for this, Clawbacks provision ensures a reduction in the risk of restatement bymaking executives repay fraudulent performance-based compensation, thereby decreasing theexpected benefit to executives from overstated financial statements. Finally, for effectiveaccountability of executives, firms should compensate top executives according to a value basedsystem; whereby they are paid on the basis of ‘flow on return’ achieved by the executiveconcerned.Human Resource personnel play a key role in organizations work processes. In light of thisperspective, Human Resources should be involved more in the determination of executivecompensation. However, according to CNS (2008) too much emphasis is placed on the softersciences of Human Resources selection, recruitment, training and development rather thandetermining the wages of executives. Their work in this area as stated by CNS (2008) is verymuch limited to helping consultants with the paperwork. To mitigate this weakness, HR couldplay a vital role in assisting executives understand how their compensation is being determined,
  5. 5. that’s if the company’s compensation policy is determined on a subjective criterion rather thanobjective performance goal. This subjective basis is one way in which goals are set so that theycan be easily achieved by the organization. Secondly, Human Resource Managers can aid theircompany determine the type of performance metrics to use, to better evaluate executiveperformance. By not getting involved in executive compensation. Human Resource executivesare losing the opportunity to influence the company’s strategy in a key area they couldunderstand completely; leadership development and succession planning. Thirdly, According toMeisinger S (2006), Human Resource professionals could provide compensation boards withfigures on the company’s overall compensation structure, examining industry best practices, and,inmost instances, develop pay philosophies and designing executive compensation plans. Finally,HR professionals according to Meisinger S (2006) are referred for the purpose of incorporatingthe various strata of executive-level compensation, compensation-legal compliance, uniformityin pay philosophies, benefits and perks-to ensure that it is on par with the organizationsperformance objectives and ethical standards. Equally, Meisinger S (2006) added that the debateover disproportionate executive compensation and the condition for greater financialtransparency have led organizations to depend on Human Resource personnel for this criticalfunction. Therefore HR as a critical component of organizations success must be more proactivein the determination of executive compensation. By failing to do this, HR is ignoring a majorpart of its role.In Conclusion, it can be argued that executive compensations are unjustified in many respects.The exorbitant compensation packages as seen in the case study examples are not reflective ofthe performance of executives, however lacking it may be. In spite of this, there are alwaysmeasures of accountability for which this essay has provided in the form of disclosure ofexecutive interests and so forth. In addition, Human Resource professionals should be moreinvolved in the formulation of executive pay and bonuses to ensure accountability andtransparency in the running of the organization and more importantly, the determination ofcompensation at all levels of the organizations hierarchy. It is therefore recommended that anysuch compensation should be subjected to a set of stringent guidelines that ensure a pay-for-value package. Moreover, executives and top level managers must be held accountable in the dayto day affairs of the organization. By failing to take heed of this arguments organizations arepaving the way for corrupt practices and other dishonest behaviors. (word count: 2062)
  6. 6. BIBLIOGRAPHYCrain News Service, 2008. HR must play key role in executive pay. [Online] Available at: <http://www.crainsdetroit.com/hr-must-play-key-role-in-executive-pay-insiders-say.htm. [Accessed on 29 April 2012]DeHann, E., Hodge, F. and Shelving, T., 2011.Clawbacks make CEOs more accountable for firms financial reporting. [Online] Available at:<http://www.foster.washington.edu/clawbacks.aspx.htm. [Accessed on 30 April 2012]EthicWorld, 2008. U.S. House committee holds hearing on CEO Pay. [Online] Available at: <http://www.ethicsworld.org. [Accessed on 30 April 2012]Meisinger, S., 2006.Good things comes in three’s for HR. Alexandria: Society for Human Resource Management. pg. 10Milkovich, G.T., Newman, J. and Gerhart, B., 2011. Compensation: Compensation of special groups. 10th Edition. New York: McGraw-Hill Irwin, pp 477 – 492Oxford, 2002.Oxford English dictionary reference. New York: Oxford University Press Inc.Perkins, S., 2009.Executive Reward. In: G White and J Druker, ed. 2009. Reward management: a critical text. New York: Routledge, pp149 – 150.Schermerhorn, J. et al., 2011. Management.4th Edition. Australia: John Wiley & Sons, pp55 – 56.

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