Running head: COMPENSATING EXECUTIVES1

COMPENSATING EXECUTIVES;

LESSONS LEARNED FROM THE PAST GENERATION

Stephen P. Burgor

Davenport University

HRMG725 Finance of Compensation and Benefits

Dr. Lynn Szostek

October 15, 2015

EXECUTIVE COMPENSATION 2

Abstract

The compensation of chief executives in particular those found within the United Sates has

found itself to be under public scrutiny over the past decade or so. An overview of

compensations towards key employees, and the challenges stockholders and executive boards

face in hiring and compensation packages offered to top leaders will be examined. Also the

strategies used in hiring, the key issues involved, and the problems and questions associated with

the process of awarding compensation to top executives will be addressed.

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Executive Compensation; Lessons Learned From the Past Generation

John Burroughs (April 3, 1837 – March 29, 1921), was a naturalist who was involved in

the American conservation movement as a writer in the 1860’s through the 1920’s. Burroughs

(n.d.) once said, “For anything worth having one must pay the price; and the price is always

work, patience, love, self-sacrifice - no paper currency, no promises to pay, but the gold of real

service” (John Burroughs Quotes). If top executives of the early 21st century would have claimed

this as their motto then national attention with regard to compensation would have been directed

to one of the many more areas of interest and not have taken stage as its primary performer.

However, it is equally important to not simply take an altruistic approach to American

capitalism.

Railroad tycoon Cornelius Vanderbuilt (May 27, 1794 – January 4, 1877), who made huge

masses of wealth during the time of great economic expansion in America during roughly the

same time period had this to say: “I have always served the public to the best of my ability.

Why? Because, like every other man, it is to my interest to do so” (Cornelius Vanderbuilt

Quotes). These men were for the most part at opposite ends of the compensation spectrum yet

both believed fiercely in their servant hood. This author will look at the compensation practices

of the early 21st century in American culture, taking the viewpoint from both ends of the

compensation spectrum. We will examine methods and practices, ask questions that the general

public would ascertain, and examine the answers that compensation teams including human

resource directors would present as solutions.

Key Issues and Problems

It is common knowledge that the general public has been up-in-arms so-to-say, showing

increased frustration and even a feeling of offensiveness at the knowledge of the compensation

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packages of top executives. This unpleasantness is currently coming from both shareholders and

the general public alike. There are many players however in this financial game of compensation

for executives. Compensation teams, boards of directors, human resource professionals, chief

financial and executive officers, and compensation consultants all have their role too. This alone,

the fact that so many different parties have their say in the hiring procedures of executives,

becomes one of the major challenges in the process of executive rewards. The stakeholders want

to see growth of company stocks. The corporate boards and/or CEO’s, the very people that

compensation professionals have to answer to, usually hire compensation teams and consultants,

causing possible conflicts of interest. Boards of directors are the spokespersons of the

shareholders yet in many ways do not take the initiative of sharing details of the competitiveness

in the hiring of executive leadership positions, whether because of time constraints or because of

the complexity of the process.

Other challenges that exists is the fact that top executives of companies typically do not

see the effects of their leadership until years after their hiring no matter if the affects are positive

or negative. Martocchio (2013) emphasizes that; “Executive compensation packages emphasize

long-term or deferred rewards over short-term rewards” (p. 321). A leader’s incentives can be

extravagant but yet only realized long after he/she spearheads successful productivity. Never-

the-less if top administrators do not perform well they can also be substantially rewarded upon

their dismissal. This further exasperates a problem. They are being rewarded for a job not well

done, during a period of decrease in the performance of company stock. In-turn leading to the

laying off of hundreds of employees. Thousands of people in this scenario are negatively

affected while the top executive is heavily rewarded upon their firing. As examples we can look

at the following:

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When executives at Hewlett-Packard, Bank of New York Mellon, Burger King

and Yahoo were asked to step down this year, they walked away with severance

packages that cost shareholders a combined $60 million.  For instance, when Léo

Apotheker stepped down as CEO at Hewlett-Packard, he walked away with $13.2

million in cash and stock severance. (Flannery, 2011, para. 3)

One must ask the question how exactly do these top executives specifically receive so

much reward, particularly in regard to showing negative results? The answer lies in the types of

rewards that top executives receive, many of them different than what most others in the

company would not even dream of entertaining. The list of benefits are long but the author will

concentrate more in this writing on benefits that are either deferred or presented later in the

executive’s career. Deferred compensation is payments given to the executive at a future date.

The reasoning is that this type of compensation acts as an incentive, striving to create a sense of

ownership in the growth of the company. If the executive receives these at a later date then

usually there is a lesser tax rate involved since he/she would receive these presumably after

retirement (Martoccio, 2013). Incentive stock options allow the executive to purchase stocks for

the future but at a predetermined price. This hopefully will be at a discounted price since the

stock under their leadership will increase (p. 325). Nonstatutory stock options are also beneficial

for future return because gains are usually greater as the company grows (p. 325). Phantom stock

is still another benefit based on long term return. Usually the executive receives these at the time

of retirement from the company (p. 326).

Another long-term benefit is stock appreciation rights. This benefit also is usually

utilized at the point of retirement for the executive. CEO’s can also receive benefits after a

termination due to change of ownership or corporate takeover. These benefits are called golden

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parachutes and are usually a part of an executive’s compensation package. These are actually

even advantageous for the company by reducing the company’s tax liability (p. 326). Platinum

parachutes “are lucrative awards that compensate departing executives with severance pay,

continuation of company benefits, and even stock options” (p. 326). Again this author wants to

point out that almost all of these benefits are ones received based upon delayed compensation.

The most challenging issue with regard to how top executives are paid though is not necessarily

how much they are paid but the fact that such a large percentage of what they are paid is not

based on performance.

One of the most famous events that caused a huge amount of turmoil was that of the

American International Group (AIG) in 2009. The New York times reported that AIG “received

more than $170 billion in taxpayer bailout money from the Treasury and Federal Reserve, [and]

plans to pay about $165 million in bonuses by Sunday to executives in the same business unit

that brought the company to the brink of collapse last year” (Andrews, 2009, para. 1).

Key Insights and Changing the Trend

An article in the Harvard review, written by Jensen and Murphy (1990) mentions that,

“In most publicly held companies, the compensation of top executives is virtually independent of

performance” (Jensen & Murphy, 1990, para. 2). Through their study of over 2500 CEO’s from

1974-1998 they came to the conclusion that:

a). top executives are not receiving record salaries and bonuses, b). Annual

changes in executive compensation do not reflect changes in corporate

performance, c). Compensation for CEOs is no more variable than compensation

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for hourly and salaried employees, and d). With respect to pay for performance,

CEO compensation is getting worse rather than better. (para. 5-8)

It seems that the public tumult over top executive compensation has changed some trends

in the business marketplace. The Dodd-Frank act of 2010 made provisions for shareholders to

have the right to vote on executive’s pay packages. Richard Feloni (2014) in a more recent

article in Business Insider, feels that the attention is a bit misguided. Feloni states the following:

“Companies' boards have responded to this regulation, and there has been a trend toward basing

CEO compensation on how well a company is doing in the market relative to its competition”

(para. 9). After all, it is the shareholders that want to have the best executive available in order

for the stocks to climb and give the best return. The focus should be rather that the rewards of

executives be based on performance. In an article written just before the Dodd-Frank act was

passed attorney Jay Rothman stated that, legislation was already in place in the United Kingdom

with regard to a more uniform compensation for executives. And also that during the time of our

nation’s outcry there was debate as to try to allow states to experiment with different proposals

but that for the most part states simply ignored the topic of out of the ordinary executive pay

(Rothman, 2013).

The passing of the Dodd-Frank in July of 2010 provided shareholders, “with a say on pay

and corporate affairs with a non-binding vote on executive compensation and golden parachutes”

(Public Files Overview, 2010). Other provisions by the passing of this law included protection

from deceptive practices and hidden fees by corporations, advanced warning systems of risks

posed by complex companies, more transparency in asset-backed securities, non-binding votes

on executive compensation, and strengthening regulators to pursue financial fraud (Public Files,

2010). With the passage of the Dodd-Frank Act it appears that the outcry from the general public

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made the federal government of the United States take action. The taking of this action by

congress then forced a trend in the marketplace by the provisions within the act. “Companies'

boards have responded to this regulation, and there has been a trend toward basing CEO

compensation on how well a company is doing in the market relative to its competition” (Feloni,

2014).

Key Questions to Ask

There remain a few points of discussion in the debate on executive rewards and benefits

and this involves the comparison between the executive and non-executives within the company.

Is the compensation gap between executives and nonexecutives justifiable? Initially because of

the vast differences in pay practically everyone would immediately say no, they are not

justifiable. However that might not necessarily be the case. Apparently there are those that

believe that the top executive’s pay is now about where it should be. What is surprising is that

some of these people are employees and shareholders. According to Feloni (2014), “There has

been rising shareholder approval of their companies' executive pay packages, according to the

Wall Street Journal. For example, in early April, 93% of companies in the Russell 3000 index

approved of their CEO's pay” (para. 16). Feloni further goes on to quote Steven Neil Kaplan

who has written extensively on compensation pay. Kaplan says,

CEO pay should be compared with the salaries of other high-earning

professionals: If you look at CEO pay compared to the average pay of people in

the top 0.1%, it's about where it was 20 years ago — in line with [that of] lawyers

and private-company executives. (para. 12)

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Additionally, Jannice Koors (2013) the managing partner of Pearl, Meyer & Partners, a

successful executive management and compensation company with numerous locations

throughout large metropolitan areas of the country, had this to say:

I think most companies are on the right track with their pay programs. Yes, CEO

pay increased this year (2013) 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. (Koors, 2013, para. 5).

It appears that the passing of the Dodd-Frank Act has corrected the wrongs of overcompensating

executives. Was this however the only reasoning for its correction? Let us continue on with a

few more pertinent questions.

Should executive compensation be given upon a person’s exit from the company or

should his/her pay be solely based upon performance? Perhaps even moving towards the point of

no reward unless stocks show significant gains? Since most of a CEO’s pay is deferred for long

periods of time it is highly unlikely that any executive would take a position that was solely

based upon straight pay-for-performance. It would also be very difficult to lure top leaders away

from other companies without at least matching their current compensation. As this author has

mentioned quite a bit of their long-term compensation is based actually already upon

performance with it being tied up in the performance of the company’s public performance of

stock options and stock appreciation. While it might look like an effective option it is not one

that would have much if any legitimacy.

Could the great recession of the U.S. economy, caused by the collapse of the housing

industry, bank and automobile manufacturer bailouts, be the reasons for so much public focus on

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executive over-compensation? There might be some legitimacy here with the timing of the

recession and the public focus on over compensated executive pay. At a time when foreclosures

and unemployment were high, mixed in with the underperformance of the stock market greater

emphasis in the public’s eye was placed on the differences between average worker pay and

heads of companies. The automobile bailout came at a least opportune time through the scope of

pay along with the bank bailouts as already mentioned with AIG and others. This author is not

stating that the public outcry towards executive compensation was not legitimate just mentioning

that greater emphasis was placed on it because of other factors in the economy. Surprisingly the

real numbers show that a fairly large percentage of CEO compensation between the years 2006-

2009 went down not up. Sarah Stodola mentions this in her article in The Fiscal Times, “almost

47 percent of CEOs saw their compensation fall between 2008 and 2009”  (Stodola, 2011,

para. 1). She further goes on to say, “Over the three years from 2006-2009, 43 percent of CEOs

saw no increase in pay” (para. 2). Therefore there does seem to be the possibility of a greater

emphasis being placed on compensation of CEOs due to the fact that the overall economy at the

time was having major concerns.

Could pay for performances actually have caused a company to under-perform? Yes, it is

possible. Let’s briefly look at this. There is a belief by analysts that because of an over emphasis

on pay-for-performance compensation of CEOs, greater risks were taken in order to attain these

larger rewards. These greater risks in-turn became greater failures. Steve Brooks (2010) in his

article in Texas Enterprise quoting two business professors at the McCombs School of Business

states the following:

The structure of CEO pay might have helped to bring on the Great Recession.

Both see a link between the lure of big bonuses and the making of chancy

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business decisions, particularly at financial services firms. The central problem,

they say, is a misalignment between pay and performance. (para. 3).

It is possible, because of an over-emphasis on pay-for-performance, that CEOs will take bigger

risks. With bigger risks there is the potential for bigger gains. Yet this of course could lead to a

larger chance of failure, putting the employees and stock-holders in a more perilous position,

causing an opposite affect than what is intended with a pay-for-performance compensation plan.

Conclusion

John Burroughs (n.d.), our naturalist from the late 1800’s also said, “A man can fail

many times, but he isn't a failure until he begins to blame somebody else” (John Burroughs

Quotes). There has been a lot of finger pointing on numerous sides of the CEO compensation

issue over the past ten years yet seemingly the issue did not materialize until most recently over

the past five to ten years. It went practically unnoticed until recent history. The reasonable public

outcry and media publicity led to changes in federal tax laws and policies with the passing of the

Dodd-Frank Act. This coincided with the major recession, bank and automobile bailouts,

unemployment, stock market plunge, and fraudulent housing industry. In most recent times

however there is less media play in the general public. Is this because the United States is

currently seeing economic growth? Are stockholders more satisfied? Is unemployment on the

downswing? Is upturn in the auto industry putting blinders on the general public in terms of

CEO compensation? There are many sides to the CEO compensation issue. There seems to be

less finger pointing very recently as the general public is also profiting far more than it had

during the great recession of 2007-2009. In some ways the problems still exist, perhaps the

greater emphasis on the problems has been lost though because of the U.S. pulling out of the

most recent recession. It is this author’s opinion that when the next recession comes, and market

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corrections/recessions always come, the public finger pointing so to say, will move again to the

forefront of focus in the business world and general public.

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References

Andrews, E. L. (Yea2009r, March 14). A.I.G. planning huge bonuses after $170 billion bailout.

New York Times. Retrieved from

http://www.nytimes.com/2009/03/15/business/15AIG.html?_r=0

Brooks, S. (2010). Texas Enterprise. Retrieved from

http://www.texasenterprise.utexas.edu/2010/12/10/finance/greed-top-ceo-pay-and-great-

recession

Burroughs, J. (n.d.). Brainy Quotes. Retrieved from

http://www.brainyquote.com/search_results.html?q=pay

Burroughs, J. (n.d.) Brainy Quotes. Retrieved from

http://www.brainyquote.com/quotes/quotes/j/johnburrou121353.html

Koors, J. (2013, August). Is CEO pay too high?. Crain's Chicago Buisness, (), .

Retrieved from http://www.chicagobusiness.com/article/20130820/NEWS01/130819903/

is-ceo-pay-too-high

Feloni, R. (2014, June). The reason CEO pay is so high right now has little to do with

greed. Business Insider, (), . Retrieved from http://www.businessinsider.com/rise-in-ceo-

pay-is-not-a-bad-thing-2014-6

Flannery, N. P. (2011, October). Paying for failure: the costs of firing America's top

CEOs. Forbes, (), .

Retrieved from http://www.forbes.com/sites/nathanielparishflannery/2011/10/04/paying-

for-failure-the-costs-of-firing-americas-top-ceos/

Jensen, M., & Murphy, K. J. (1990, May-June). CEO incentives—it’s not how much you pay,

but how. Harvard Business Review, (), . Retrieved from https://hbr.org/1990/05/ceo-

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incentives-its-not-how-much-you-pay-but-how

Martocchio, Joseph J. (2013). Strategic compensation (7th ed.). New Delhi, : Pearson Education.

Public Files. (2010). Retrieved from

http://www.banking.senate.gov/public/_files/

070110_Dodd_Frank_Wall_Street_Reform_comprehensive_summary_Final.pdf

Rothman, J. (2007, March 8). Executive and board compensation trends. . Retrieved from

http://www.foley.com/files/Publication/1fd38abc-cddb-47f1-900b-

bb0d8de16105/Presentation/PublicationAttachment/5b51508a-92b5-4c42-b93e-

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Stodola, S. (2011, April). . The Fiscal Times.

Retrieved from http://www.thefiscaltimes.com/Articles/2011/04/21/CEO-Pay-Survey-

Big-Payouts-in-Spite-of-Recession

Vanderbuilt, C. (n.d.) Brainy Quotes. Retrieved from

http://www.brainyquote.com/quotes/quotes/c/corneliusv618009.html