The current financial crisis is shaping today’s world substantially by questioning sustainability of existing market and economic principles. The supposedly free markets are suddenly in desperate need of government bailouts where taxpayers’ money is used to cover mainly for the irresponsible and greedy individuals. It has been argued that the big banks, insurance and automobile companies are too big to fail, because their bankruptcy would adversely affect all of us. Why are these big companies failing? Do CEOs of these giants play any role in this, and if yes, how big? The recent announcement of the Goldman Sachs’ CEO, Lloyd Blankfein, saying that he and his colleagues are going to abstain from sky-high bonuses this year made me to think about their compensation as a possible evil that might have contributed to the financial turmoil spiral. The purpose of this essay is to examine CEO compensation from two opposing views – are CEOs compensated justifiably high for their work or are their salaries way overshot?

Research in this field suggests that there is little evidence in favor of equitable compensation, hence, a hypothesis about too high CEO compensation seems to be more plausible. Specifically, CEO compensation is usually incentivized by huge stock option packages that often represent an irresistible temptation to drive the stock prices up by any means (on average, 60 - 80% of top executive compensation comes from stock options). The theory that rising stock price of a company benefits all stakeholders is nice, but unfortunately does not always work well. What the practice tells us is that while managers keep focusing themselves only on the stock returns, other stakeholders and their interests are often being neglected.

Board of directors is an important supervisory body within a company, which is supposed to oversee CEOs’ actions and, at the end of the day, approve his or her compensation bill. Yet, board of directors members are often closely connected to a CEO and might be willing to cooperate with him too much, hence, lose their primary role – represent interests of shareholders.

In theory, both, stock option packages as well as board of directors are instruments designed by companies with the aim of helping them to improve their business as well as run it more efficiently. However, practice often tells us the opposite story.

It is believed that CEOs are compensated based on company performance. However, research and recent survey in the field of investment banks, discount brokers and asset management companies have found out that there is a weak correlation between executive compensation and company performance (measured by various performance metrics; i.e. revenues, stock price, profitability ratios…etc.). Surprisingly, a more statistically significant correlation was found between CEO compensation and a non-performance related metric, size of a company. Therefore, companies with the highest market capitalization will have most likely CEOs with the highest compensations.

The business environment in the past decade was significantly affected by the rising stock markets, which also surged thanks to unrestrained pursuing maximization of shareholders value. Ethics, representing a transparent, honest and considerate behavior, was subdued to a behavior that was (only) acceptable and, hence, did not play any major role in managerial decision making. Unfortunately, we have been given several excellent examples (Enron, Andersen…) of how self interest of CEOs can ruin the whole many years well built and managed company. Greed is in us, therefore, embedding effective preventive measures that will also apply to top level management seems inevitable. How to do that?

In his article (2003), Mel Perel lists several radical solutions. First, a random choice of a CEO might well prevent his or her interdependency with board of directors. Another essential step would be introducing salary caps that are already established for example in professional sports. These ideas might seem inacceptable to many people, but I believe that there is something interesting about them and they could start a serious discussion on how to bring back an ethical dimension into our daily business life.

Literature:

Perel, M.: An ethical perspective on CEO compensation. Journal of Business Ethics, 2003.