Executive Compensation
Executive compensation refers to the remuneration packages provided to top executives in corporations, which typically include base salary, bonuses, stock options, and various perks like corporate aircraft and cars. This form of compensation has become a contentious issue, particularly due to the growing income disparity between executives and average employees, with the ratio increasing dramatically from 20 to over 295 times average salary between 1965 and 2013. The structure of executive pay often ties remuneration to company performance, but there are concerns about the potential for short-term gains to overshadow long-term stability, as evidenced during economic downturns. Additionally, disparities in executive pay can reflect broader issues of inequality, including gender and racial biases. Efforts to regulate and improve transparency around executive compensation have been introduced, such as the Dodd-Frank Act's "say on pay" provisions and requirements for companies to disclose CEO-to-employee pay ratios. Despite these attempts, corporate lobbying has hindered the implementation of more comprehensive reforms. The ongoing debate about executive compensation raises important questions about fairness, accountability, and the role of corporate governance in shaping pay structures.
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Executive Compensation
High managerial pay has been controversial since the advent of the modern corporation. Executive compensation is typically structured differently from most workers’ pay, with packages that include stock options and severance. Between 1965 and 2013, the disparity between the pay of executives and their employees has grown from twenty times average salary to more than 295 times average salary, according to a 2014 study from the Economic Policy Institute. Total packages reach as high as $131 million per year. Such disparity was a factor in the 2011 Occupy Wall Street movement and other protests against income inequality.
Overview
Executive compensation typically comprises base salary, perquisites (such as personal use of corporate aircraft, company cars, business expense accounts), annual incentives, and long-term incentives (LTI). According to a Hay Group/Wall Street Journal survey, average CEO pay jumped 11 percent in 2010 but slowed in subsequent years, climbing 3.6 percent to $10.1 million in 2012. Overall levels of executive compensation have been justified by companies’ boards of directors based on business volatility and the related risks to managers.
The dramatic increase in executive compensation dates back to the 1970s, when pay for leaders grew while wages for other workers stagnated. Though a wave of hostile corporate takeovers in the 1980s sought to impose stricter shareholder governance, corporate leaders walked away with “golden parachutes” (i.e., generous severance packages) while rank-and-file workers lost their jobs. Executive compensation has risen steadily since, with brief interruptions during the dot-com bubble and the global financial crisis of 2007–2010.
In 2012 a greater proportion of executive pay shifted toward LTI, which grew to an average of $7 million. LTI includes restricted stock that does not reach full value for a specified period of time, along with cash performance rewards. Tying remuneration to stock options theoretically orients executives toward maximizing the stock price—a tactic known as pay for performance. Yet the financial downturn of 2008 demonstrated the consequences of rewarding short-term value while inviting long-term failure. Departing CEOs often receive large bonuses, regardless of company performance.
Public company directors are legally responsible for monitoring and rewarding company leaders. Most utilize a compensation committee that includes some board members. This may explain inequality in pay for women and ethnic minorities, as members of the same in group tend to favor one another. For that reason, the gender gap in executive pay is smaller when companies have more women directors. Research has shown that supposed meritocratic pay can be especially susceptible to racial and gender bias.
Theorists who believe in market efficiency argue that politicians and shareholders do not have the information needed to accurately assess compensation as directors do. By contrast, some management theorists argue that close relationships between executives and directors, including the practice of interlocking boards, prevents adequate regulation of compensation. Likewise, reliance on salary surveys to comparable firms may increase the bar for all executives.
Federal regulations have been proposed to improve disclosure of executive pay, and capital gains tax legislation has influenced the makeup of executive compensation packages. Tax rates on the highest income earners has encouraged the shift toward stock options, which are taxed as long-term capital gains and thus at a lower rate than short-term capital gains and income. In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act codified “say on pay” provisions for proxy filings disclosure of executive compensation and the right of shareholders to an advisory vote on pay packages. The Dodd-Frank law also required publicly traded companies to disclose a comparison of the compensation of the chief executive officer and that of a typical employee, a statistic called the CEO pay ratio. In 2013, the US Securities and Exchange Commission proposed a rule that would have required companies to disclose the median annual total compensation of all their employees, which could then be compared with executive pay. However, corporate lobbyists have prevented such proposals from taking effect as of June 2015.
Bibliography
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