Paper 2: CEO Compensation


The highest paid Chief Executive Officer (CEO) in 2011 reportedly earned nearly $378 million (CNN Money 2012).  A vast majority of his compensation package consisted of stock options and grants, while the rest came from salaries and bonuses. What kind of firm offers such an enormous pay package? Apple—one of the most successful firms of recent decades. Although this compensation amount is publicly available, many wonder if it is justified. After all, $378 million is more than the nominal GDP of several small nations.  From what sources should executive compensation come from? Do executives deserve this amount of compensation? This paper will explore the rationale for executive compensation and the ethics behind the dollar amount.

Apple is a unique company that has revolutionized the personal computer industry. Among other related software and service items, it is involved with designing, manufacturing and marketing personal computers, media devices and portable music players. Its brand equity and brand loyalty is one of the most impressive in the entire business world. Apple enthusiasts are proud and defensive of the enterprise.  Since 2003, its profits have increased from $68 million to over $41 billion, an increase of almost 61,400% (MSN Money). As CEO of Apple, Tim Cook earns $378 million a year. This amounts to $1.04 million a day or $43,000 an hour. Apple stock (NASDAQ: AAPL) is currently priced at approximately $527 per share. Cook’s 2011 compensation was comprised of a cash salary of approximately $900,000 and a one-time stock option award valued at $634 million as of April 2011 (Singer 2012).

Tim Cook isn’t the only chief executive who is generously compensated. As the fourth highest paid executive in 2011 with a total compensation of over $96 million, Larry Ellison of Oracle also has not been able to avoid the spotlight on the aggressive compensation he receives. Oracle Corporation is a multinational computer technology company that creates both software and hardware products for businesses worldwide. Its rise is attributed to the technology boom of the 1990s and its products are increasingly in demand as businesses strive to improve their data management systems. Oracle operates in a highly capital-intensive business and, accordingly, operates with high profit margins. Ellison, Oracle’s co-founder, CEO and Director, is the greatest recipient of Oracle’s substantial compensation packages. He is not shy to show off some of his prized possessions, which include cars, jets, yachts, multiple homes, and islands. In 2001, Ellison received an annual compensation of $706 million (ICMR). Oracle’s 2012 Proxy Statement praises Ellison as a technology visionary and one of the world’s most successful business executives. Additionally, it states that “he continues to lead the development and execution of our business, technology and acquisition strategies and for more than 30 years has successfully steered Oracle in new strategic directions in order to adapt to and stay ahead of our competition and changing industry trends.” It is clear that Ellison is essential to Oracle’s success and is widely respected. In the past year, Ellison’s compensation rose 24% despite a 23% decrease in the company’s share price during that period. Ellison’s compensation mostly consists of stock options, making him the largest shareholder (he now owns almost a quarter of Oracle stock).

To justify its notoriously high executive compensation packages, Oracle offers this rationale in its 2012 Proxy statement: “Our long-standing approach to executive compensation is to provide total compensation opportunities that are significantly above the average of our peer group… [and] reward those individuals only if they are successful in achieving our two primary business objectives: driving year-over-year growth in our non-GAAP pre-tax profits…and increasing Oracle’s stock price.” Oracle’s compensation committee aims to reward executives with compensation that reflects individual skills and experience relevant to the company’s size, scope and complexity. Ellison’s personal compensation mix includes 94.3% in stock options, 4.1% in performance-based cash bonus, a $1.00 base salary and 1.6% in “other.”

Although Tim Cook of Apple is arguably an outlier in the debate on the merits of extraordinary executive compensation, pay packages like the one Larry Ellison receives is no fluke or oversight on behalf of compensation committees in the United States. Many argue that the chief executives of publicly traded companies like Oracle, Google and CBS, to name a few, are justified based on the size and importance of the enterprises they run. Additionally, companies are keen to provide enough incentive to retain worthy CEOs that offer unique insight or experience.

A study by the Institute for Policy Studies and the Center for Corporate Policy published in 2007 presents several arguments against any action to reduce CEO pay. In the study, Gregory Mankiw, Professor of Economics at Harvard University and former economic advisor to President Bush, stated in 2006 that “CEOs are paid what they are worth to their companies, and their high pay reflects the extraordinary value of their talent.” Additionally, the demand of top-quality CEOs is significantly higher than the supply, thus making high CEO compensation a necessity in order to attract and retain executives.

Another argument in support of high executive compensation relates to the amount of shares that CEOs are awarded. The CEOs that hold a large percentage of a firm’s shares “naturally require a higher pay level because they bear more risk due to the large equity portfolio” (Matsumura, et. al). Additionally, some argue that executives deserve to be rewarded based on the performance of the company’s stock price. Stock price, they say, is an appropriate indicator of the performance of the company and the CEO. It should make sense, then, for the CEO to be focused on his or her company’s stock price due to the risk and performance indication it provides.

Although justified by some, excessive CEO compensation is not without its critics. For example Analysts often look at the ratio of pay difference between CEOs and regular line workers. The greater the difference, they say, the larger the ethical issue (Spires). Although this ratio has shrunk since 2000, when this issue was under much scrutiny, it still remains at about 209-to-one, or 10 times higher than in 1965 (Verespej 2012). In 2000, this gap was about 411-to-1; in 1980, it was about 40-to-1, and in 1965, the ratio was just 18-to-1. An analysis in the 2012 annual report by the Economic Policy Institue (EPI) think tank found several staggering facts. Most notably, “from 1978 to 2011, CEO compensation increased 725%, compared with an increase in compensation for workers of only 5.7%” (Verespej 2012). As Brandon Rees, the deputy director of the A.F.L.-C.I.O. office of investment puts it, “American workers are having to make do with less, while C.E.O.s have never had it better” (Singer 2012). In the case of Larry Ellison, his 24% increase in compensation in spite of a 23% decrease in Oracle’s stock price does not seem justified. If CEOs salaries should be aligned with the performance of their companies’ stocks, then Ellison’s pay should reflect Oracle’s stock performance.

Some evidence has suggested that, by solely focusing on stock prices, CEOs are maliciously attempting to increase their wealth. Although this notion is extreme, there is also evidence that firms protect CEOs from “downside risk” by lowering the exercise price on previously granted stock options (Matsumura, et. al). This is another reminder that it is important to keep a watchful eye out for the negative consequences of giving CEOs compensation packages overloaded in stock options.

The methods to control CEO compensation are limited. In their book Pay Without Performance: The Unfulfilled Promise of Executive Compensation, authors Bebchuk and Fried argue that “[the Board of] Directors have relatively few reasons to oppose higher CEO pay as long as it falls within what is considered conventional and acceptable” (p. 36). Shareholders do not have any direct influence on an executive’s pay in a public company, and the Board of Directors may approve the compensation packages even if they aren’t in the shareholders’ “best interests” (Matsumura et. al).

Unfortunately, a benchmark can be hard to form for this issue. It seems virtually impossible for every corporation to follow the same lines of ethics and guidelines when it comes to paying their executives. Immanuel Kant offers unique perspective on business ethics that may be useful in determining an appropriate level of executive compensation. Kant argues that to achieve meaningful work, the firm must be a moral community that considers the interests of all affected stakeholders. A firm in today’s world must value each stakeholder in order to achieve success. Stakeholders “have dignity or a value beyond price” (Bowie 1999). Not to say that corporations ignore and belittle other stakeholders besides management, but the wage gap present between CEOs and average workers might imply some lack of fairness and inability to see the true value in a firm’s employees. A policy such as open book management, in which all employees can access financial information about the company at any time, fosters “respect for persons” and positive freedom. Kant would say that a fair wage is one that allows an employee to “exercise independence and provide for physical well-being and the satisfaction of some of the worker’s desires.” Employers have an obligation to provide a just wage and if wages are too low for an average worker, they should be re-assessed. But what does this say about executive compensation? Kantian ethics requires democratization and therefore requires the participation of stockholders and employees to give their consent to policies surrounding CEO compensation.

One way to bring this idea of participation within a company to life is through “say on pay,” which arose in the wake of the 2009 financial crisis. Thanks to the enactment of the Dodd-Frank Act in the United States, “say on pay” has attempted to control the amount of executive compensation by allowing shareholders to vote on the company’s compensation policies. Unfortunately, “say-on-pay” has not been as successful as originally intended. Although the act forced some firms to adjust pay programs to better reward performance, it did not solve the solution of excessive compensation. Russell Miller, the managing director at ClearBridge Compensation Group stated “If say-on-pay was intended to decrease the absolute pay levels of CEOs, I don’t think it’s going to do that” (Gilbert 2011).

Whether or not “say on pay” is successful, it brings to light an issue that needs attention. A.G. Lafley, the former chairman and CEO of Proctor & Gamble wrote a column for the Harvard Business Review in 2010 that calls CEOs to “take a stand.” He says that CEOs must speak up about unacceptable and inappropriate amounts and forms of compensation before legislation and the public take control of the issue. He argues that CEOs must ensure that all of their actions are intended to “consistently create value over the short, medium, and long term.” If a CEO is successful, his/her compensation will be reflective of his/her performance. He says that post-employment provisions not pegged to performance should be eliminated because they are not tied to a CEO’s performance during employment. Getting rid of other incentives like change-in-control payments, gross-ups and severance would greatly restore trust in management from the public, shareholders and the government

Should Kantian ethics inspire some enterprises like Apple and Oracle to re-assess their executive compensation packages, these firms might find that autonomy is easier to enforce over time. Linking CEO compensation more closely to CEO performance and ensuring that a just wage is provided for all might have more positive effects for the whole company. Apple’s and Oracle’s executive compensation packages may, in fact, be justified, but a certain level of attention and participation is required to make that decision. If compensation packages are appropriately distributed, CEOs might be more attuned to the needs of each stakeholder group, which in turn may have positive effects on stock price. Justifying the executive paycheck does not simply sound nice in principle, it is necessary for a moral community to form and be sustained.

 

 

Works Cited

“25 highest-paid men”. CNN Money. October 2, 2012. http://money.cnn.com/gallery/magazines/fortune/2012/10/01/25-highest-paid-men.fortune/index.html

“Apple Inc”. MSN Money. http://investing.money.msn.com/investments/company-report/?symbol=AAPL

Bebchuk, L. and Fried, J. Pay Without Performance: The Unfulfilled Promise of Executive Compensation. Cambridge: Harvard University Press. 2006.

Bowie, Norman. “A Kantian approach to business ethics”. Blackwell Publishers Limited. 1999.

Finkle, Jim. “Oracle boosts compensation of billionaire CEO Ellison.”

Gilbert, Katie. “Has Dodd-Frank’s ‘Say on Pay’ Limited Executive Pay? Yes and No”. Institutional Investor. July 2011.

Lafley, A.G. “Executive Pay: Time for CEOs to take a stand”. Harvard Business Review. May 2010.

Matsumura, E.M. and Shin, J.Y. “Executive Pay Reform: Likely Consequences and Ethical Issues”. J. Mack Robinson College School of Business: Georgia State University.

Oracle Inc. 2012 Proxy Statement Form DEF 14A. Morningstar Document Research. http://www.oracle.com/us/corporate/investor-relations/sec/index.html

Singer, Natasha. “In Executive Pay, a Rich Game of Thrones”. The New York Times. April 8, 2012. BU1.

Spires, Steven. “CEO Compensation as an Ethical Issue – When Does it Cross the Line?” J. Mack Robinson College School of Business: Georgia State University.

Verespej, Mike. “CEOs vs. average Joes: Pay gap wide, new study shows”. Waste and Recycling News. September 17, 2012. Vol 18 pg 3.

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