CASE 15-1 CEO COMPENSATION: DO THEY DESERVE ROCK STAR PAY?

Cant sing, dance, or hit a baseball out of the park? You can still earn big bucks by becoming a CEO of a Fortune 500 firm, according to the AFL-CIO, who used data gathered from the Department of Labor, Bureau of Labor Statistics. The average pay for a CEO in 2016 was $13.1 million based on an analysis of 420 firms in the S&P 500 index. From the workers perspective (average earnings of $37,632), a CEO earns in 1 day what a worker earns in 1 year (335 times an average workers pay in 2015, 347 in 2016). Worse, while the pay of the average worker increased by 2% from 2015 to 2016, CEO pay rose by 6%. Taking inflation into account over a 50-year time period, wages of this workforce were actually less than stagnant; in 1967, workers earned 10% more than in 2016, the equivalent of $41,473 adjusting for inflation.

The AFL-CIOs research clearly indicates that while the country as a whole has grown and unemployment is at a near all-time low, the worker in the United States is not similarly prospering as compared to his or her counterpart in corporate headquarters. There is a growing wage gap, a gap clearly that does not seem equitable from the largest federation of US labor unions as well as the general public.

Why such a high salary given the fact that the US economy has grown at most 2% per year over last few years, one-third of the growth of CEO salaries? US CEO pay is often high because it is based upon the average pay of their peer group. The AFL-CIO suggests that to eliminate this practice, similar to British concerns, shareholders have binding votes on CEO compensation. Yet the reality is that in 2015, 91% of investors advisory votes in S & P 500 firms supported CEO pay levels.(1)

Stockholders aside, the general public certainly feels that CEOs are overpaid. Stanford Universitys Rock Center for Corporate Governance in 2016 ran a national study (1,202 participants who reflected US socio-demographics including age, gender, race, household income, state residence, and political affiliation) tapping into peoples beliefs concerning the compensation packages of the 500 largest publicly traded corporations.

The net result? Nearly three-quarters (74%) think CEO pay is out of synch with worker compensation, with only 16% thinking otherwise. Socio-demographic differences aside, most individuals feel quite adverse when discussing CEO compensation. According to Professor David F. Larcker of Stanford Graduate School of Business,

There is a clear sense among the American public that CEOs are taking home much more in compensation than they deserve. 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.(2)

CEO pay needs to be dramatically cut since their salaries are off the chart. How this is to be accomplished though, with or without government regulation, is where disagreement arises and usually along political affiliations. For example, while both groups feel that there should be a ceiling on CEO pay (nearly 65%), those who hold Democratic and Independent affiliations differ with Republicans by almost 15% (66%/64%/52%, respectively). When it comes to actually setting a cap on CEO pay, those surveyed thought that six times the average worker pay was acceptable. This is way below the average multiple of all CEO pay, which is 17.6.

Interestingly, there was nowhere near a majority consensus on how to use regulation to limit CEO pay. Some advocated large tax increases over a certain level (28%), others opted for setting dollar amounts relative to worker wages (25%), while a minority wanted to set pay ceilings not tied to worker pay (17%), and a similar percentage wanted CEO pay directly tied to firm performance. Only 9% thought to eliminate stock options, while another 8% would cut out all forms of equity compensation.(3)

Yet many experts do not agree with the public and would argue the public does not have all of the facts. Jannice Koors, managing director at 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 yearbecause 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.(4)

Donald Delves, director, Towers Watson in Chicago, justifies CEO pay as follows.

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.(5)

Author of The Taboos of Leadership Anthony Smith noted that

The reality is that the free market is alive and well, and is the true dictator of CEO pay. While what ones 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 microeconomics 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. Its pure Economics 101.(6)

Whether you agree or disagree with the fairness of CEO pay, CEOs make as much in one day as the average worker makes in one year.

Questions

1. How does ethics apply to this case?

2. What factors might contribute to what some perceive as unethical behavior concerning CEO pay?

3. What are the differing ethical approaches, and how might they apply to this case?

4. How might the issues of CEO compensation be dealt with in a firm's code of ethics?

5. How might the i