Compensation plans for Private Sector CEO’s in North America are Reasonable PDF

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Lately, the trend is more leaning towards people/lower level employees claiming CEO compensation being very high and the candidate not deserving of the high pay. That is partly because we hear of cases where very highly paid CEO’s drove the company to bankruptcy and caused losses to all the sharehol...

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Running Head: COMPENSATION PLANS FOR CEO

Compensation plans for Private Sector CEO’s in North America are Reasonable

HRM 831NUU Ted Mock February 12, 2020

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Compensation plays a major role in the success of a company. Employees drive a company and the leader of any company is the driving force behind all of them combined. Every year there are articles, papers and research being done on the amount of CEO compensation for the public and private sectors. Lately, the trend is more leaning towards people/lower level employees claiming CEO compensation being very high and the candidate not deserving of the high pay. That is partly because we hear of cases where very highly paid CEO’s drove the company to bankruptcy and caused losses to all the shareholders. Stuff like this does happen, but there are so many success stories too where the companies skyrocketed because of the strategic vision of the CEO, examples include Jeff Bezos of Amazon, Steve Jobs of Apple, Mark Zuckerberg of Facebook and more. So, this and other research related to theories of executive compensation and the compensation plan mix for the top executive has led me to go in favour of the statement that “Compensation plans for private sector CEO’s in North America are reasonable.” Kenton (2019, para 1) defines CEO as “the highest-ranking executive in a company, whose primary responsibilities include making major corporate decisions, managing the overall operations and resources of a company, acting as the main point of communication between the board of directors (the board) and corporate operations and being the public face of the company. A CEO is elected by the board and its shareholders”. Breaking down this definition, CEO is called the public face of the company, which means that if the CEO fails to meet company goals and objectives, then he is the one to get the fall for it so likewise should be the case for the CEO succeeding in making money for the shareholders, he should get an equivalent reward.

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McCullough (2019) in his article highlights the various factors which are the reason for CEO compensation being high. He argues that its not like the CEO works hard, hard work is done by even a person who sweats for hours in the sun, picking up heavy equipment. Hence it shows that the risk factor for a CEO job is much higher, if a lower level employee does not show up and perform their duties, the company will have a cheap fix to it and he/she can be substituted but if the CEO screws up, the company can go bankrupt and thousands/millions of people can lose their jobs. The CEO work is more competitive than what meets the eye. Salary rates are determined using a lot of different factors. Labor Market Model or more commonly known as the Job Market, has a great impact on compensation. According to this model if the supply of labor is more compared to its demand, the compensation will be lower and if the supply is low and demand is high, then the compensation will be higher. The same case can be applied for the CEO compensation. Top executives generally go through a rigorous amount of training, have high qualifications and reach that position after years of hard work. But even after putting in so many years, not everyone gets selected for the CEO position. Apart from education, experience and training, it also requires the correct mix of skills and abilities and since that mix is so rare, the supply of such individuals is low. Hence the compensation must be high in order to attract and later on retain that person and forget worries about him leaving the firm for some other competitor who can offer him a higher pay. However, O’Reilly, Main & Crystal (1988) propose in their article that there are counter arguments such as why the pay difference between a CEO and the vice president is so high, the vice president is also considered elite talent and they should share in the company success as well. This makes the case for a substantially high CEO pay unreasonable. The theory given by

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Lazear and Rosen, 1981 (As cited by O’Reilly, Main & Crystal, 1988) explains the executive salary difference well. This theory states that your salary could triple in amount from when you become CEO from vice president. It assumes the CEO salary as a lottery/tournament winnings. The employees are the tournament participants and whoever wins the tournament gets the ultimate prize (CEO salary). The purpose of this super high salary is to send a signal through out the organization, that the reward to hard work is worth it. Hence, it is not about whether the CEO deserves that pay or not, it is more about motivation for competitive employees to one day take that position and earn that reward. Another factor that affects the CEO compensation is the firm size. Compensation varies from a big company to a small company by very high numbers. Cooper (2019) stated in his article that “The average private company CEO total compensation package for 2017 was $2,213,679, but the median was a more modest $350,622”. The drastic difference between the average total and the median shows that actually the pay for most companies is not so high, but because the big companies pay a lot, the average figure comes out high and gives the impression to the general public of compensation being too high to all CEOs of all companies. Nonetheless, we can see that there is a substantially high difference in pay between the CEO of a small company and that of a big one. Motivational theories like Maslow, Alderfer and Herzberg all agree that money is the steppingstone to any further motivation and if that need is not met, further motivation cannot happen. Which is why it is important that the compensation plan be designed in such a way that the employee can think beyond money and focus on the company performance. However, these theories consider money to only a certain extent, after that extent money becomes secondary and

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it comes down to sense of ownership, future security, power etc. (T. Mock, personal communication, 2020) Executive Compensation. (n.d.) breaks down executive compensation package into various factors and these factors compensate the need for ownership, future security etc. These are usually 

Base pay: Generally base pay is just 20% of a CEO package.

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Short term incentive (Bonus): These include various incentives for meeting short term goals (performance objective) of the Company like annual bonus.

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Long term incentives: These are for meeting the goals and objectives of the Company for a longer period of 2-5 years. It can be in the form of performance shares, performance units etc.

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Other benefits & perquisites: These can be in form of Restricted Stocks, Stock options etc.

Stocks are the most popular method these days for awarding CEOs. Board of Directors are the ones to decide CEO compensation. Stocks in the form of compensation are beneficial because they align the stockholders interests with that of CEO performance. When the company performs well in the stock exchange company, the results can be seen in the form of Share values going up. Restricted stocks are considered the best for aligning the interests of the company with that of CEO. Restricted stocks are company shares granted but they cannot be cashed unless certain conditions are met, these conditions could be anything like CEO meeting certain goals and objectives or the shares being blocked for a certain time limit of 3-5 years so that the CEO cannot resign. Let’s look at the compensation pay mix for CEO in the recent years of 2009, 2012, 2015 & 2018.

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Figure 1. Stock grants drive increase in CEO pay. Adapted from “2019 U.S. Executive Compensation Trend” by J. Roe & K. Papadopoulos, 2019. Retrieved Feb 06, 2020, from https://corpgov.law.harvard.edu/2019/04/16/2019-u-sexecutive-compensation-trends/. Copyright 2019 by Roe & Papadopoulos.

As we can see from the chart above, for the years 2009 – 2018, the CEO pay mix has been constant for almost all the variables through out the years except for a considerable rise in the Stock component. Companies have started to pay more in terms of Stocks so that the rise and fall of CEO pay is directly co-related to the company performance. We have established a link between CEO pay and company performance, the supply and demand of talent and the difference in CEO pay for a large organization to a small one. Summarizing it all, despite of a few variances, in most of the cases we can safely conclude that the CEO does not get paid more for their day to day activities, they actually get paid a lot only if they meet the company goals and objectives and are successful in increasing the share value of the company with their strategic vision, knowledge and skills. In short, the amount of money they make is directly proportional to the amount of value they put into the company.

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References

Cooper, W. (2019, April). CEO and Senior Executive Compensation in Private Companies 201819. Retrieved from https://chiefexecutive.net/ceo-and-senior-executive-compensation-inprivate-companies-2018-19/ Executive Compensation. (n.d.) Retrieved from https://www.salary.com/articles/executivecompensation-it-starts-with-the-ceo/ Kenton, W. (2019, August 18). Chief Executive Officer. Investopedia. Retrieved from https://www.investopedia.com/terms/c/ceo.asp McCullough, D. (2019, October 11). Why Do CEOs Make so Much Money?. Foundation for Economic Education. Retrieved from https://fee.org/articles/why-do-ceos-make-so-muchmoney/ O’Reilly III, C., Main, B. G. & Crystal, G. S. (1988). CEO Salaries as Tournaments and Social Comparisons: A Tale of Two Theories. Administrative Science Quarterly, June 1988. Retrieved from https://www.researchgate.net/profile/Brian_Main3/publication/279185294_CEO_Salaries_as_ Tournaments_and_Social_Comparisons_A_Tale_of_Two_Theories/links/53e654eb0cf21cc29 fd2bdd5.pdf Roe, J. & Papadopoulos, K. (2019). 2019 U.S. Executive Compensation Trends. Retrieved Feb 06, 2020 from https://corpgov.law.harvard.edu/2019/04/16/2019-u-s-executive-compensationtrends/...