Article: Compensation for CEOs: How much is too much?

Compensation & Benefits

Compensation for CEOs: How much is too much?

What could be the possible reasons for the 'gravity-defying' executive compensation and are they justified?
Compensation for CEOs: How much is too much?

It is argued that if an organization does not pay CEOs at or above the market, they will leave and go to a competitor


 What could be the possible reasons for the ‘gravity-defying’ executive compensation and are they justified? 

 James Gorman, CEO, Morgan Stanley, perhaps ruffled a few feathers, when in an interview to FT (October 2012) he said that in the industry the compensation ‘is way too high.’ He argued in his interview that, ‘What the Street has historically done is when revenues went up; they kept the comp-to-revenue ratio flat. When revenues went down, they increased the comp-to-revenue ratio because they said, ‘We might lose all our people. We have to increase it.’” Further according to AFL-CIO’s Executive Pay Watch Report, the ratio of CEO-to-worker pay between CEOs of the S&P 500 Index companies and U.S. workers widened to 380 times in 2011 from 343 times in 2010. These two when read in conjunction lends credence to why shareholder voices cry foul and often use terms such as ‘fat paychecks’ and ‘gravity-defying’ for the high levels of executive compensations. Yet, despite the fact that corporations in the US have been widely criticized for their approach to executive compensation, the fact remains that executive pay keeps climbing.

Is India any different when it comes to executive compensation? Not really. According to Grant Thornton International Business Report (conducted by Experian in May-June 2012) 78 percent of respondents affirmed that senior executives at large public companies were paid ‘too much.’ A recent study by consulting firm Hay Group, titled the 'Top Executive Compensation Report 2012-13', with insights from 158 organizations, reveals that as compared to the top management team – CEOs are paid 3 times more than all other senior executives. This multiplier goes up to more than 4 in industries such as Basic Resources and Retail. Yet another global study by Aon-Hewitt reveals that that India has the widest gap between the salaries of CEOs and entry-level graduates. In India, a CEO's compensation is on an average 675 times that of the minimum wage earned by entry-level graduates. The US comes second with a 423 times difference. China, interestingly, ranks far lower in the list with the ratio at 268 times. Why is it that the ratio is so skewed? Sridhar Ganesan, Rewards Practice Leader, Hay Group India, reasons, “Impatience for business results has lead to recruitment of ‘Ready-made CEOs’ and is one of the reasons for variance in the compensation multiplier across sectors.”

It is argued that if an organization does not pay CEOs at or above the market, they will leave and go to a competitor. However, Charles M. Elson et al, Director, John L. Weinberg Center for Corporate Governance at the University of Delaware, in their new research question the transferability of executive skills set. They argue that, “There is no conclusive empirical evidence that outside succession leads to more favorable corporate performance, or even that good performance at one company can accurately predict success at another.” If this be so, then does it imply that CEOs are paid higher because they are more competent that their peers?

A recent paper from the University of Pennsylvania and New York University on relationship between executive pay to executive skill, concludes that particularly in big firms, a high salary doesn't necessarily mean that a CEO is more competent than his or her peers. Taking all these into consideration, one may be tempted to reason that a higher CEO pay would result in shareholder wealth maximization. But here too, there are not enough researches that paint a positive picture.

Nevertheless, CEOs and their ilks are paid highly so that they are motivated enough to face the business challenges and, instead of making value-destroying choices, choose actions that generate the maximum value for the organization. In the present global business context, it would make more sense to keep executive compensation (a business expense) reasonable and competitive.

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Topics: Compensation & Benefits, C-Suite, #TotalRewards

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