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ANALYZING MANAGERIAL DECISIONS: The Debate over CEO Compensation The most visible and highly paid person in most terminated. The CEO of General Growth Proper- corporations is the chief executive officer (CEO). ties received compensation of $66.7 million even CEO compensation is particularly important to though the firm spent most of 2010 in bankruptcy. firms for three reasons. First, the compensation From 1980, the increasing use of stock options package is likely to be important in attracting and and restricted stock grants has boosted the sensitivity retaining good CEOs. Second, the form of the pay of the average CEO's wealth to firm performance. contract is likely to help determine whether the However, the absolute sensitivity of CEO wealth to CEO focuses on value maximization or some other performance remains small. Research indicates that objective, Third, employees throughout the organiza- for a $1,000 change in firm value, the wealth of the tion carefully follow their CEO's pay. Important average CEO of a large public corporation changes morale problems can occur when employees think by under $10 (depending on the year and estimation that the CEO is overpaid. For instance, employees method). Some argue this relation (which is equiva complain bitterly when they are asked to take pay lent to the CEO owning less than 1 percent of the cuts because the company is in trouble, yet at the common stock) is too small and that most compa- same time the CEO gets a big raise. nies would be better off if they increased incentive Controversy over CEO pay has increased sub- pay for CEOs. Some support for this view seems to stantially in recent years. One charge is that the come from studies that document an increase in level of CEO pay is too high. CEO pay is so huge stock price when companies announce that they are that people don't believe they deserve it. It is casy increasing incentive pay for CEOs. to point to many CEOs who report compensation in the millions of dollars (reported compensation fig- 1. Do you think the fact that most American ures typically include salary and bonus payments, CEOs are paid so much more than rank-and- as well as the expected value of stock option and re- file employees suggests CEOs are overpaid? stricted stock grants). Consider the following two Explain. examples. Investors were outraged when the giant 2. Japanese CEOs generally receive much lower Swiss drug company Novartis gave its departing levels of compensation than CEOs in the chairman, Daniel Vasella, $78 million as part of a United States. Does this imply that U.S. CEOs non-compete contract, whereby Vasella would keep are overpaid? collecting his annual salary so long as he didn't go 3. Is it obvious that $10 per thousand is too low work for a competitor. After this turned into a giant of an incentive pay for CEOs? Explain. PR disaster, Vasella and the board called the whole Does the observation that the stock price thing off. In 2009, Hewlett-packard laid off 6,400 increases when firms increase incentive pay for workers but paid its CEO Mark Hurd $24.2 million. CEOs suggest that most CEOs do not receive In 1980, CEO compensation was 42 times that of enough incentive compensation? Explain. the average worker. In 2013, it was 331 times. 5. Are there any reasons why overpaying CEOs The second major criticism of CEO pay con- might be in the shareholders' interest cerns how CEOs are paid. Critics argue that CEOs (ic, maximize shareholder value)? are agents of stockholders and that CEO pay should be based heavily on stock-price performance. In Source: M. Herper (2013) "Novartis' Exorbitant Pay Package For Former CEO Was More Piciculous Than It Locked" Forbes (Feb- some celebrated cases CEO pay appears discon- ruary 10; N. Hindman (2011). "The 10 Highest-Paid CEOs Who nected to CEO performance. For example, the CEO Laid Off The Most Workers, " Huffington Post (September Ijt of the health care provider Mckesson not only www.allcin.org Corporate-Watch/Paywatch-2014, K. Murphy 1013). "Executive Compensation Where We Are, and How We earned $145 million in 2013 but also received an Gol There " in G. Constantirides, M. Harris and FL. Stult (Eds) employment agreement containing an eye-popping Handbook of the Economics of Finance Vol 2, Part A, (Elsenior $469 million severance payout should he be Amsterdam, 211-356: A. Lomax 2011) "CEO Pay Defies the Laws of Gravity." The Motley Fool December 16)