There is a pervasive sense among the public that something is wrong with the system and the philosophy of executive pay in Corporate America. A recent report of executive compensation revealed that over half of CEO’s in large corporations are paid $7.1 million annually. The lowest paid in the survey was paid over $450,000. These figures do not necessarily include the value of all perks to these CEO's. The term “earned” lies at the foundation of the debate and thus is avoided for purposes of discussion here. Over the past decade, the disparity between top executive pay has widened to the point that CEO pay is in excess of 75 times the average pay of non-executive employees in the same companies. The debate goes beyond any “class warfare” arguments. The essential question goes to corporate governance and whether a responsible Board of Directors could rationally justify the high compensation and perks awarded to these CEO employees. This issue has come under increased scrutiny as executives are given tens of millions in “severance” package compensation when the company they were charged to lead experienced very substandard performance, in some instances bankruptcy.
Many of the arguments put forward to justify such compensation lack coherence and substance. No one argues that high levels of talent and performance should be denied high levels of compensation. However, there seems to be very limited positive correlation between the actual performance of the Companies and the level of compensation paid to the CEO. For example, the argument is used that corporations must pay very high compensation levels to attract and keep “star quality” executives. The example of pro athletes is advanced as a model. However, one would be hard put to find a pro athlete who is paid more than $71 million per year in salary alone. Athletes like LeBron James, Michael Jordan, Tiger Woods and others earn their high compensation levels through a combination of sports competition, performance incentives, sponsorship contracts and investment ventures. In addition, they must consistently perform at very high competitive levels that are evident to the public in order to maintain such high compensation levels. The CEO of Yahoo who was paid the highest compensation among those in the survey led a corporation whose stock and profit performance have consistently trailed that of Google.
Another area in which the purported justifications fail to hold water lies in the size of the gap in compensation. Companies that are laying off tens of thousands of employees still pay tens of millions of dollars to the CEO in annual compensation. A general sense of equity and logic suggest that the excess funds could be more effectively used for the benefit of the corporation and its shareholders by investing them in measures to improve plant and equipment, upgrades to technology or other steps to improve competitive performance rather than rewarding substandard performance of the chief executive.
In a simplistic sense, “executive” entails the inherent concept of “execute” or performance. If the CEO fails to develop and execute a profitable strategy, the diversion of corporate assets to an extremely high compensation package seems illogical. It is true that some strategies require time to develop and implement and stability of leadership is a valuable asset. Like any investment, the CEO should accept risk and receive reward based upon thye success of the venture. However, if the CEO lacks faith in his or her own strategy and ability to successfully implement that strategy, why should that CEO be rewarded and compensated in advance of demonstrated results?
Ultimately, the economic dislocation affects the entire economy and becomes a public interest issue. In general terms, it makes little sense for the government to get into the business of regulating executive pay. The mechanisms of corporate governance and shareholder accountability, if functioning properly, should rectify gross abuses. However, the public has seen too many examples of late where such accountability is not functioning and the resulting consequences have created havoc and serious damage to the public. The collapse of Worldcom and Enron and similar scandals demonstrate that the negative consequences of failed corporate governance fall on helpless pensioners, employees and government coffers. In this sense, the government is already “involved” in regulation at some level.
One way to encourage accountability is transparency. Recent statutory requirements that CEO’s and CFO’s sign and attest to the accuracy of financial reports is a sore point for many corporate executives, but does require an increased level of transparency for public companies. Another more aggressive approach might be to link the tax deductibility of executive pay as a “legitimate” business expense to some concrete measures of corporate capitalization and profitability. If a corporation was losing millions of dollars, for example, the IRS could simply prohibit the deduction of any CEO and senior management compensation beyond some level based upon minimum compensation to CEO’s of corporations of the same class. For example, the survey mentioned is based upon corporate reporting required by law. It showed salary compensation of the lowest paid CEO at around $450,000.
The suggested proposal would not prohibit a corporation that is losing money from paying a $10 million salary to its CEO. However, only $450,000 would be tax deductible as an expense. The Board of Directors would thus be required to justify to shareholders the basis for the excess compensation that cut into operating capital. Additionally, the level of deductibility could be tied to a percentage of corporate profits. The logic of the proposal is that the Board of Directors could fashion any level of compensation package they chose. However, the taxpayer subsidy for the compensation would be limited by actual performance by the executive. This is not undue government regulation; it is instead the limitation of government subsidies for irrational and undeserving purposes that provide no benefit to the public. It would represent sound tax policy to combat government welfare to the wealthy. Most of the public believe that getting by on $7 million per year, instead of $70 million, would not be an undue hardship for a CEO whose performance has not been shown to be stellar. Many would be ecstatic to "get by"on a tenth of that lesser amount.
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