CEO compensation structures and implications

CEO Compensation

Despite Crystal's criticisms of executives earning outrageous sums of money that are not linked to their performance, the reality is that most executives have a compensation package that is based on performance in some way or another (Codon and Lynch, 2004). However, the use of stock options and other equity-based incentives create enormous incentives to manage the performance of companies for short-term stock price gain. This often comes at the expense of strategy implementation that could sacrifice profits in the short-term for long-term benefits. Also, underlying executive actions there may be the desire for personal wealth, not the strength of the corporation obtained through a well thought out strategic plan.

Of the recommendations offered in the case, the two that are the most promising are linking pay to long-term profitability and putting workers on the boards of directors. Instead of being pressured to make quarterly and annual profits, incentives based on long-term profitability free CEO's to focus on the company's future. Management should also restore the relationship between wages and profitability by sharing the wealth through all levels of the organization (Glassner, 2002). Putting workers on the board is one way to make sure that if the rank-and-file has to make financial sacrifices, so should the company management. In turn, when the company experiences increased profitability, all levels of the organization should benefit.

Other suggestions to the problem of high executive compensation are less promising than linking pay to performance and worker participation in boards. Board participation by bankers and stockholders may actually increase the focus on short-term profitability because they have often have short-term financial incentives themselves. If companies expense options at the time they are granted, it will be difficult to continue to grant options to as many employees, leaving CEO's the most likely candidates for shares that can be granted. Disallowing tax deductions for CEOs with pay that is 25 times higher than the average for blue-collar workers would affect small companies more than larger ones and does nothing to align executive behavior with the best interest of the company. Internal pooling isn't always the best option for CEO replacement and doesn't necessary ensure that the successor will have the proper incentives, even if the overall compensation package is lower.

3. Shareholders, employees and the general public are all placing increased pressure on boards of directors and compensation committees to appropriately review the compensation paid to executives and how the package encourages them to behave. In particular, there has been increasing shareholder concern over the dilution caused by equity compensation plans along with greater media scrutiny in light of corporate scandals such as Enron, WorldCom and Tyco, to name just a few. Increasingly, companies are beginning to realize that actions taken by CEOs who are motivated by the wrong things can damage a company's reputation, brand and market capitalization. Economic recession and resulting declines in profitability are yet other key factors driving a reevaluation of the way executives are paid. In lean times, companies are less likely to tolerate inefficiencies such as excessive pay structures and the resentment of workers grows when executives continue to make huge salaries while they face pay cuts and layoffs. Ultimately, the market dynamics caused by an extraordinary competitive environment demand that businesses develop the appropriate incentives to motivate the type of executive behavior that will foster corporate success.

4. It's not clear from the case, how much the pay of a CEO is justified by the performance of their companies. Crystal's research shows that there is only a small relationship between pay and performance while Kay and Robinson reach an opposite conclusion. Regardless of which side is right, it's hard to defend the extraordinarily high levels of executive compensation paid to CEOs even in cases where there is outstanding performance. CEO compensation that is 200 times higher than rank-and-file employees indicates an extreme imbalance in financial reward in the organization and has negative consequences for overall employee performance.