Executive Compensation For Organization’s Long-term Viability attached is the discussion instructions and required reading material. please respond substan

Executive Compensation For Organization’s Long-term Viability attached is the discussion instructions and required reading material. please respond substantively to the questions and utilize the required amount of scholarly sources to support claims. Executive Compensation:
After reviewing the Coleman (2016) article on executive compensation and reading this week’s
assigned readings, choose one of two statements below and construct an argument supporting
your position:
a. The market trend towards escalating executive compensation reflects the critical
importance of an executive to an organization’s long-term viability.
b. The growing compensation inequity between executive management and the average
employee threatens to destabilize organizational morale and societal justice.
Guided Response: Be sure to cite at least two scholarly references, in addition to the course text
and the article (4 total).
Reference for Article:
Coleman, B. (n.d.). Executive compensation. Retrieved from http://www.salary.com/executivecompensation-it-starts-with-the-ceo/
9
Executive Compensation
and Extreme Pay
iStock/Thinkstock
Learning Objectives
After reading this chapter, you will be able to:
1. Define what constitutes extreme pay.
2. Recognize the legal and regulatory ramifications surrounding extreme pay.
3. Understand what factors go into creating an executive compensation plan.
4. Appreciate the pros and cons of providing extreme pay to executives.
5. Explain the different components that compose executive compensation.
6. Apply the theories of extreme pay to nonexecutives.
7. Understand how extreme pay is affected by the size of the company.
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Introduction
?
Introduction
Earning $5,653 per hour?!? Is that right? How can that be?
Yet, $5,653 is the mean hourly pay (salary plus other compensation) for CEOs of five of the
top companies in the S&P 500 Index.1 And this amount is by no means the highest rate paid
to CEOs. For example, David Zaslav of Discovery Communications Inc. made $156,077,912 in
2014—that’s $50,025 per hour!
When pay for executives—or celebrities or elite athletes—is discussed, it’s common practice
to show the per hour rate to highlight the extreme amount of pay in comparison to that of the
typical worker. After all, the federal minimum wage is only $7.25 per hour and these executives are earning $5,653 per hour. That’s a huge discrepancy!
It’s not simply a matter of comparing per-hour rates, however, as there are numerous factors
in play with regard to executive and other high-paying positions. Additionally, the above-hour
rate for CEOs is based on the largest companies, which understandably would have higher
compensation levels than the average company. Based on CareerOneStop, a website sponsored by the U.S. Department of Labor, the average hourly pay rate for CEOs is $83.33 per hour,
which ranks 10th on the list behind numerous health care positions (U.S. Bureau of Labor Statistics, 2014d). As you can see, not all executives make the headline-catching amounts often
portrayed in the media.
Some companies have tried to address the issue of high discrepancies between CEO and
worker pay. Ben & Jerry’s is famous for its founders making a pact to maintain a 5-to-1 pay
ratio between the highest salaried executive and the lowest-earning worker. They maintained
that pact for 16 years, until one of the founders retired. At that point, they couldn’t find a
qualified candidate who would accept those terms, so the company had to raise the ratio,
ultimately increasing it to 17 to 1, before being acquired by Unilever. The feature on gravity payments provides another example of a company that tried to address the issue of high
executive pay but ran into its own set of issues as a result.
1
Hourly rate based on working 60 hours a week for 52 weeks.
Compensation and Benefits in the Real World:
Gravity Payments
Seattle-based Gravity Payments received a flurry of media attention when owner and
CEO Dan Price announced that the company would be setting a minimum annual salary
of $70,000 for all employees, including the CEO, who cut his salary to $70,000. This
announcement resulted in the acquisition of several new clients but also the loss of existing
customers. Some left because they thought the company was making a political statement,
and others left because they thought there would be a fee increase to the clients in order
(continued)
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Section 9.2
Legal and Regulatory Issues
Compensation and Benefits in the Real World:
Gravity Payments (continued)
to pay for the change. In addition, several top-performing employees left the firm because
they did not view it as fair that many lower-paid employees would receive significant pay
increases while they would receive little or no increase in their own salary.
Read the story here: http://www.seattletimes.com/seattle-news/seattle-company-copes
-with-backlash-on-70000-minimum-wage.
In this chapter, we will cover extreme pay for both executives and nonexecutives. We will
address the legal and regulatory factors in play with executive compensation and extreme
pay. Next, we’ll look at how executive pay can be used as a competitive strategy as well as
cover the specifics involved in executive compensation, including salary, incentives, and perquisites. We’ll then look at how extreme pay applies to nonexecutives, such as celebrities and
athletes. We end the chapter with a discussion of how executive compensation and extreme
pay might look at small companies.
9.1 Defining Extreme Pay
Let’s start by looking at what exactly extreme pay is. While there’s not a common definition
for what constitutes extreme pay—what might be extreme to one person is just on the high
end for another—we can look at extreme pay in terms of the definition of extreme. MerriamWebster defines extreme as “very great in degree” or “exceeding the ordinary, usual, or
expected” (“Extreme,” n.d.). Applying that definition to pay, we can look at extreme pay as
compensation that is atypically very high. From a practical standpoint, and for this discussion,
we will define extreme pay as what an individual in the top 2% to 3% of households makes,
which as of 2015 would be around $200,000 to $250,000.
9.2 Legal and Regulatory Issues
In the past, companies were able to set their own levels of executive compensation without
much regard to outside legal forces. This resulted in a wide range of executive compensation
levels. Some executives were paid disproportionate salaries or given very generous perks
in relation to other employees, while other executives were paid on par with other employees. Without any true oversight, companies essentially were able to do as they wished. While
this was okay for the majority of companies, some executives took advantage of this lack of
oversight by paying themselves at levels that were outside the realm of reasonable business
practices. This is by no means a new concern in business, as the excesses of the aptly named
Robber Barons in the late 1800s to early 1900s demonstrate (Josephson, 1934; Weathington
& Hall-McKane, 2013).
More recently, however, the meltdown of various financial institutions during the Great Recession, including the bankruptcy of many long-standing companies, brought compensation
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Section 9.2
Legal and Regulatory Issues
practices to the forefront. Companies were losing vast amounts of money at the same time
as their executives were making millions of dollars in compensation. Politically, the issue
could no longer be ignored. Therefore, in the wake of the Great Recession, various legislative
changes occurred that affected how companies could set their compensation structure.
Structure of a Company
Before getting into this issue further, let’s take a moment to explain how decision making
regarding executives is supposed to work. For a publicly traded company, the shareholders,
those who own shares of the company’s stock, elect the board of directors to represent their
interests in company decisions. The board of directors is tasked with overseeing the activities of the company, including hiring the CEO and setting his or her pay. The CEO then hires
the rest of the employees and is in charge of day-to-day operations. Typically, the CEO is
responsible for hiring the senior management team, such as the chief financial officer and the
chief operations officer, who then hire the members of their team. See Figure 9.1 for an
illustration.
Figure 9.1:
Structure of a
public company
The board of directors is
elected to represent the
interests of shareholders
while overseeing the
activities of the company.
Under this structure, it is the responsibility of the board of directors
to take into account all the policies and procedures we’ve discussed
in previous chapters to set a reasonable compensation structure for
the CEO, who then uses a similar practice for members of his or her
senior management team. Competition plays a big part in setting
executive compensation levels, just as it does for other employees,
as companies aim to attract, recruit, and retain executive talent.
Corporate Governance
Shareholders
elect
Board of Directors
hires
CEO
hires
Senior Management
hires
Rest of Employees
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Corporate governance can be defined as the policies, procedures,
and controls implemented by an organization to guide its actions.
The intent of corporate governance is to keep any of the major players in an organization—namely the board and executive management—from abusing their position. No one is to treat the company
as a personal bank by having unfettered access to the company’s
resources. Checks and balances are intended to be put in place to
keep one party from having excessive control of or access to the
company’s resources.
Since the board of directors is essentially the head of the company
(it’s not practical for the shareholders, the owners of the company,
to serve in this role), the board is responsible for governing the
company. Part of its job in governing the company is setting the
compensation level for the CEO. The compensation level should be
set using unbiased decisions that take into account the executive’s
qualifications, the complexity of the organization, competitive factors, and other such elements. There are numerous examples, however, where boards did not follow this process. Instead, it became a
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Legal and Regulatory Issues
Section 9.2
crony system of “You approve my pay, I’ll approve yours.” In practice, the boards of organizations often became interconnected, where the CEO of one company served on the board of
another, and that CEO served on the first one’s board, and many of the same people served
on the boards of several of the same companies. The boards no longer looked at the policies,
including compensation policies, with an unbiased eye, thus negating one of the most critical
responsibilities of a board.
In good times, the lack of true oversight was not as obvious. In difficult times, however, the
lack of oversight attracted attention. This became evident following the corporate scandals
involving deliberate fraud and corruption by companies like Enron and WorldCom in the
early 2000s.
More scrutiny was called for as it became obvious boards were not acting in the interest of
their shareholders (or community, in the case of nonprofits). This scrutiny led to the passage
of the Sarbanes-Oxley Act (https://www.sec.gov/about/laws/soa2002.pdf), which, among
other provisions, required independent boards for publicly traded companies. (Note: While
the act technically applies only to public companies, market pressures are making it difficult
for private and nonprofit companies not to comply with the provisions of the act. If these
organizations do not put the controls required by the act in place, they face a more difficult
time raising capital for business needs as well as potential losses of customers, investors,
employees, and suppliers due to public sentiment and backlash.)
An independent board is one in which the
majority of the members do not have a relaCritical Thinking
tionship with the company other than serving on the board. This means the majority
How is corporate governance supposed
of members do not do business with the
to work in properly monitoring
company (in other words, are not a supplier,
executive compensation? Do you think it
customer, or consultant of the company or
is an effective method? Why or why not?
affiliated with a company that is), nor do they
receive monetary compensation from the
company except for fees for serving on the
board. The point of an independent board is to avoid conflicts of interest so that its members
are not influenced by personal interests in the company or by personal ties to the company’s
management team. Instead, they should be able to make decisions in a fair and impartial manner that best serves the shareholders and company as a whole. While not perfect (there are
always loopholes that some individuals will try to exploit), the Sarbanes-Oxley Act does put
mechanisms in place to make companies create policies to provide the proper guidance and
not to disregard their responsibilities and skirt the rules as was done in the past. In addition,
it highlights the need for true corporate governance by independent parties to best serve the
needs of the organization’s stakeholders, which include the owners, customers, employees,
and community in which the organization operates.
Dodd-Frank Wall Street Reform and Consumer Protection Act
In response to the Great Recession and the impact the lack of financial oversight had on the
economy, the Dodd-Frank Wall Street Reform and Consumer Protection Act became federal
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Section 9.2
Legal and Regulatory Issues
law in July 2010. Dodd-Frank, as the law is commonly known, made significant changes to
financial regulations in the United States. The main focus of the law was to improve transparency and accountability in the financial system in an effort to avert future financial crises.
Table 9.1 details the provisions that relate to executive compensation.
Table 9.1: The Dodd-Frank as related to executive compensation
Section of law
What it does
Implementation
951
• Requires advisory votes of shareholders about
executive compensation and golden parachutes
• Requires specific disclosure of golden parachutes in merger proxies
• Requires institutional investment managers subject to Section 13(f) of the Securities Exchange
Act to report at least annually how they voted on
these advisory shareholder votes
October 2010—provisions
related to institutional investment managers
January 2011—provisions
related to shareholder votes
about executive compensation
and golden parachutes
• Requires additional disclosure about certain
compensation matters, including pay for performance and the ratio between the CEO’s total
compensation and the median total compensation for all other company employees
September 2013—provisions
related to pay ratios
April 2015—provisions related
to pay for performance
952
953
954
• Requires disclosure about the role of and potential conflicts involving compensation consultants
• Requires the Securities Exchange Commission
(SEC) to direct that the exchanges adopt listing
standards that include certain enhanced independence requirements for members of issuers’
compensation committees
• Directs the commission to establish competitively neutral independence factors for all who
are retained to advise compensation committees
• Requires the commission to direct the exchanges
to prohibit the listing of securities of issuers that
have not developed and implemented compensation clawback policies
June 2012
July 2015
Source: US Securities and Exchange Commission, http://www.sec.gov/spotlight/dodd-frank/corporategovernance.shtml
Section 951 is known as “Say-on-Pay” because it requires a company to include in its proxy
statement a nonbinding resolution for shareholders to approve the compensation of executives. The proxy statement is the document required by the SEC that a company must send
out to shareholders before its annual meeting to provide information about the company’s
plans so that the shareholders can make an informed decision regarding matters that will be
brought up in the meeting. The “Say-on-Pay” provision requires a company to include an advisory vote on executive compensation at least every three years and a resolution at least every
six years to determine whether shareholders will be presented with a vote on the compensation of executives every one, two, or three years. This section also covers golden parachutes,
which are agreements between the company and specific employees of the company, typically executive management, that provide lucrative benefits to the employee in the event
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Section 9.2
Legal and Regulatory Issues
the company is acquired and the employee is out of a job. The employee typically receives a
combination of a large severance payment, a generous bonus, and substantial stock options.
Under this provision, at any meeting where shareholders are to approve an acquisition, sale,
or merger of the company, the proxy statement must include details regarding any golden
parachute agreements with executive management and an opportunity for shareholders to
vote on the issue under a nonbinding resolution. Even though these provisions are nonbinding, the intent is for public opinion to cause the majority of companies to give full attention
to the results of these votes. Companies would then face backlash and outrage, from boycotts
by customers to difficulty raising capital for operations, if they blatantly ignore the wishes of
shareholders. This gives shareholders more impact on executive compensation practices than
might originally be thought given the nonbinding nature of the provisions.
Section 952 has provisions to promote the independence of compensation committees, which
are charged with setting the compensation practices for the executives of the company. These
provisions range from disclosing any possible conflicts of interest between a compensation
consultant and the company to requiring the security exchanges to prohibit the listing of a
company that does not have an independent compensation committee.
Section 953 covers providing data regarding the compensation for the CEO compared to the
compensation for all other employees. Specifically, this section requires a company to detail
the total compensation of the CEO, the median compensation of all other employees, and the
ratio of the CEO’s compensation to the median compensation of all other employees. Additionally, this section also requires a company to disclose “pay for performance,” which is the
relationship between the executive compensation actually paid to the CEO and the company’s
financial performance as well as the performance for its peer group. This information has to
be disclosed for the last five fiscal years, with the exception that smaller companies have to
provide the information for only the last three fiscal years.
Section 954 requires companies listed on the
national exchanges to develop and implement policies regarding clawback provisions.
A clawback provision gives the company
the ability to recover from an employee any
incentive-based compensation that was paid
in error due to material noncompliance with
financial reporting requirements any time
in the three preceding years. Companies are
also required to disclose their policies regarding incentive compensation that is based on
financial information covered under reporting laws.
Critical Thinking
Pick one of the provisions of the DoddFrank Act. Explain what the provision
does and how effective you think it is
at accomplishing that goal. What would
you add, delete, or change about the
provision to make it more effective?…
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