Introduction
On the one hand, fairness in executive compensation is a simple issue, as it boils down to elementary ethical principles. On the other hand, it isn’t straightforward and consists of several aspects. One of the main problems related to executive compensation ambiguity is the “agency problem,” when the CEO acts in interests other than shareholders’. Another problem is the imperfection of the shareholders-oriented compensation model, when the company loses sight of organizational processes, including employee dissatisfaction. These problems can be addressed by implementing executive compensation models that are based on performance assessments. Besides, problems with the fairness of executive compensation may indicate other organizational deficiencies that can be addressed in a targeted manner and by ensuring the creation of healthy labor relations and an atmosphere of transparency and non-discrimination. This paper aims to present a literature review that will discuss the topic of fair compensation for leaders of large organizations.
Background
When the question of fairness or unfairness of executive compensation is raised in society, it is usually about large companies owned by investors. As investors’ job is to invest in potentially successful projects, they hire CEOs who run the company and lead it to prosperity, increasing productivity and boosting its stock in the market (Kennedy, 2005). Investors are shareholders or joint owners of the company, while the CEO does not need to own a share.
However, as a rule, to create a sufficiently high level of motivation, investors offer a portion of the shares to the CEO. The rise in these shares’ prices reflects the level of remuneration, which can sometimes be prohibitively high. At the same time, executive directors typically receive additional salaries, amounting to $ 10 million per year (Carpenter & Yermack, 1999). Many scholars point out that for the board of directors and shareholders, the decision to overcompensate for executives can be taken as the only guarantee of project success. But in practice, high levels of remuneration do not always guarantee the effectiveness of leaders. Therefore, scientists urge boards of directors and shareholders to use differentiated models for assessing the effectiveness of managers and introduce an integrated approach to enterprise management.
Notably, in the late 1990s, the issue of fairness in executive compensation received significant publicity in the United States and even attracted the attention of Congress, the Securities and Exchange Commission, the FASB, and the Internal Revenue Service (Carpenter & Yermack, 1999). Moreover, excessive compensation has been criticized by ordinary shareholders, trade unions, and politicians. Ordinary shareholders believed they should get more from the company’s success in the market. Besides, critics have argued that the compensation process involves conflicts of interest between directors, executives, and consultants (Carpenter & Yermack, 1999).
However, over time, the issue of fair rewards has ceased to be acute. With the changing marketplace and many tech companies’ arrival, the approach to management and remuneration has shifted. In particular, for many leaders of technological start-ups, intrinsic motivation associated with the direct achievement of the desired goal has become important (Girous, 2014). After the peak of the technical boom, and since the late 90s, managers’ compensation has decreased significantly. Scientists note that the prevalence of intrinsic motivation gives hope that executives will be more interested in achieving long-term goals than in a quarterly increase in share prices (Girous, 2014). Changes can also lead to the greater importance of the social responsibility concept, which has become part of the organizational culture of many companies. Regulatory changes in the legislation of many developed countries can gradually help companies find the perfect balance in executive remuneration. Finally, academics point out that leadership can come from the corporate sector, citing examples from Amazon chief Jeff Bezos and media mogul Warren Buffett.
Fair Pay for Executives
Fair pay for executives is a turning point and strategy to tackle overpayment problems. In particular, Eklund (2020) developed a system according to which managers’ performance should be assessed and remuneration calculated. The scientist notes that there are two basic remuneration systems – focused on stakeholders and shareholders. The first system is preferable since it considers all stakeholders who are part of the business processes, in contrast to the second, which meets the needs of only one category of participants. However, the first system is also imperfect since it overly indulges those participants who make a minimal contribution to the development of the business. According to Eklund (2020), his KISS model of remuneration is the optimal one, where K stands for ‘keep it,’ I – ‘Integrated,’ S – ‘Situational,’ and S – ‘Strategic.’ Moreover, the scientist presented ten criteria for the remuneration of managers, which he considers to be universal.
Since these criteria provide a comprehensive assessment of the qualities and aspects of leadership responsibility, they are worth citing in this paper. In a holistic model developed by Eklund (2020), compensation has ten components: pay for financial performance, pay for non-financial performance, pay for sustainability, and pay for resilience. The other five components are: pay according to peers, pay according to firm risk, pay according to culture, pay according to strategy, pay for integration, and pay for characteristics, competence, and individual performance. In his book, Fairness of CEO Compensation, Eklund explains this model in more detail and provides historical facts about the changing attitudes towards executive pay in the United States (2019).
The author criticizes the widespread practice according to which remuneration for managers could grow to fantastic amounts for an ordinary employee. The direct monetary remuneration could be a relatively small amount, and the bulk of the CEO’s income came from owning shares in companies. On the one hand, Eklund (2019) recognizes that motivation with options usually has a positive effect since CEOs increase companies’ productivity at times. However, the potential drawbacks of this approach imply a relative non-involvement of the CEO in organizational processes. And given that the board is primarily focused on strategic decision-making, organizations using such a model are usually characterized by a lack of governance and all sorts of functioning problems.
Therefore, the author’s ten-component model allows us to pay more attention to assessing the CEO’s direct responsibilities, which go beyond improving the company’s efficiency in the market and increasing the value of shares. Besides, since questions about unfair executive compensation usually arise when there are other problems in the organization, this KISS model is universal in the author’s opinion. On the one hand, this model allows to solve the problem of fair remuneration and, on the other hand, to assess which areas of the organization’s work require additional management attention.
Making Boards More Independent
The problem of unfair executive compensation also has a downside. This drawback is associated with the latent influence of leaders on the board of directors when the company’s real power becomes concentrated in the hands of one person. Kennedy (2005), in his review of the book, Pay without Performance: The Unfulfilled Promise of Executive Compensation by Lucian Bebchuk and Jesse Fried provides a critical assessment and summary of the main concepts from a book where the authors criticize this state of affairs. In particular, the authors call this situation an “agency problem” since the board of directors loses control over the executives, who may have excessive informal powers. And it becomes unclear whose agent CEOs are and who they represent – shareholders and the board of directors, or themselves.
The authors give examples of executives influencing the board of directors since not all of its members are truly independent. Some may be dependent on the CEO or indebted to him, as in Enron’s case, where the CEO made donations to a university whose board member was a professor. Obviously, in this case, the CEO will have an undue influence on decision-making. In other instances, the CEO may even shape and determine the level of compensation that directors receive. The authors believe that in this case, the board of directors will be more loyal to the CEO than to the shareholders they represent. Moreover, it is not uncommon for CEOs to influence board appointments, which gives them even more power.
In this context, the board of directors is usually more inclined to accept the CEO’s compensation terms. As a result, shareholders suffer, whose interests can be taken into account in the second place, and the remuneration may not be related to CEOs’ performance (Kennedy, 2005). The scholar notes that CEOs usually receive significant rewards and bonuses when the industry and market are doing well, but they are customarily not penalized for poor performance. The author gives an example of when Hewlett Packard’s board fired a CEO for poor performance but gave him $ 21 million.
Therefore, to achieve justice, the authors of the book propose “to make boards or at least compensation committees, more genuinely independent of managerial influence” (Kennedy, 2005, p. 143). Scientists also insist on “making compensation packages more transparent to shareholders” (Kennedy, 2005, p. 143). As part of the second measure, scholars consider it necessary to “calculate a value for all forms of compensation paid to executives” (Kennedy, 2005, p. 144). Therefore, Eklund, Bebchuk & Fried, and Kennedy all agree on the need to create a model that will measure CEOs’ performance and calculate remuneration according to their success.
Other Models of Executive Compensation
Other academics offer their generic executive compensation models. For example, Schneider (2013) developed a model based on the Managerial Power Theory of executive compensation, which is especially relevant in leaders’ maintaining the value of companies’ shares. The scholar notes the dangers of psychological and social factors that distort executive remuneration. Further, Rodgers & Gago (2003) proposed an Ethical Executive Compensation Model. According to scholars, applying freedom and equality concepts helps to identify areas where executive compensation schemes need to be improved.
Wade et al. (2006) found an interesting phenomenon in the relationship between CEO pay and the rest of the workforce. According to scholars, CEOs with high rewards seek to raise the salaries of their subordinates. But, in this case, the overpayment of the CEO requires even more expenses from the shareholders. Moreover, scholars recognize that lower-level managers showed a willingness to leave the organization when they were underpaid and when they were not overpaid as much as the CEO.
Finally, Arnold & Grasser (2018) conducted a study among representative voters and investment professionals. The study found that the fairness of managers’ compensation was very important for both groups, while opinions about the amount of fair compensation were different. Arnold & Grasser (2018) found that the perceived fairness of compensation was influenced by the vested interests of study participants, who were more inclined to assess compensation as fair in the case of personal benefits. Moreover, scholars learned that executive compensation perceptions as unfair differ significantly in investment professionals and ordinary employees. The researchers concluded that outrage in the capital market and public anger at unfair compensation for managers vary significantly, depending on personal interest and assessing remuneration size. Therefore, based on this study, we can conclude that such ambiguity in assessments that exists in organizations is additional evidence of the need to develop universal models of executive remuneration that would take into account all organizational factors.
Executive Compensation in Non-Profit Organizations
Ronquillo et al. (2017) presents an analysis of non-profits in terms of executive compensation and draws attention to the approximate level of compensation for similar positions in commercial companies. In particular, scholars present the data showing that the annual compensation for half of the directors exceeds $ 5 million per year, and another third receives from $ 1 to $ 5 million. Simultaneously, in commercial companies, executive compensation can be as large as $ 10 million a year (Girous, 2014). Therefore, analogies can be drawn between these two types of organizational structures.
Interestingly, one of the important differences between non-profit organizations and commercial organizations is that more laws regulate their activities, which can be a good example. Specifically, Selden (2017) notes that US non-profits must determine the compensation level for their executives following the IRS definition. The scientist also cites research by Nikolova (2014), according to which the introduction of monitoring in the form of reporting, auditing, or observing the behavior of leaders of non-profit organizations was a determining factor in a lower remuneration for executive directors. This ‘lower’ pay was likely fair, given that the compensation was calculated according to many criteria.
Gender Inequality in Executive Compensation
Noteworthy, gender also has an impact on executive remuneration. In particular, many scholars admit that gender inequality persists among CEOs of large companies. Al-Shaer & Harakeh (2020) note that in companies where women play the CEO role, this position receives less monetary compensation and equal compensation in the form of options than in cases where the CEO is a man. Scholars also note that board members receive lower remuneration if the company is headed by a woman (Al-Shaer & Harakeh, 2020). Other scholars look at the concept of ‘conditional conservatism’ in women and imply this factor negatively affects job satisfaction, motivation, and board performance.
However, it must be recognized that lower salaries for CEOs, which are at least in some sense comparable to those of employees, can have a positive effect on the trust of the team in the leader, while excessively high pay sometimes leads to shallow motivation among the rank employees. In any case, executives should be compensated depending on their work and the achievement of company goals. Many scholars regard option compensation as a successful solution since, in this case, CEOs have a common motivation with shareholders, try to achieve maximum efficiency, and, accordingly, higher prices for the company’s shares. Logically, this rule applies to women leaders as well.
It is gratifying that the labor market situation in terms of gender inequality continues to level out. According to Al-Shaer & Harakeh (2020), over the past 20 years, the unevenness in wages between men and women in the UK has decreased from 17.5% to 8%. Such results may not reflect the situation globally, but the trend is quite impressive. There are several laws in the UK today, according to which companies must either provide equal salaries for their employees of both sexes or report to the responsible institutions why they do not. According to Girous (2014), the practice in other European countries, including Germany, is more stringent in this regard, with the requirement for mandatory compliance with the legislation requirements on equal wages and a system of fines. Similar legislation could be introduced in the United States, but due to many market participants’ residual desire for deregulation, such laws may not be introduced soon.
Interestingly, Al-Shaer & Harakeh (2020) note that gender inequality in executive compensation is easily explained by the Taste-Based Discrimination Theory. According to this theory, if the employer – in this case, the board of directors or the company owner – is not inclined to hire employees, he will pay them less. In such a case, a discriminatory situation will arise in the workplace. The preferred employees will have more rights and opportunities for initiative than the so-called ‘tokens,’ which the employer was forced to hire. Therefore, according to academics, laws that force employers to make certain decisions – for example, to ensure an adequate percentage of women in leadership positions – do not actually solve the problem. On the other hand, scientists observed situations in which, if the percentage of women in leadership positions was 50% or more, they could unite to defend their rights and initiative and receive higher salaries. According to scientists, this phenomenon is consistent with the Critical Mass Theory of Kanter.
Conclusion
Thus, a literature review discussed the topic of fair compensation for leaders of large organizations. While it may have seemed to society and academics in the past that generic models aimed at providing truly fair remuneration would not be accepted by boards of directors and shareholders, there is more room for positive outcomes today, especially among technology companies. Diversified remuneration models will ensure fair remuneration for managers and also solve internal organizational problems. Besides, companies’ success will benefit from board independence and an ethical work environment that promotes gender equality and ethnic diversity on boards of directors and senior management.
References
Al-Shaer, H., & Harakeh, M. (2020). Gender differences in executive compensation on British corporate boards: The role of conditional conservatism. The International Journal of Accounting, 55(1), 20-31.
Arnold, M. C., & Grasser, R. (2018). What is a fair amount of executive compensation? Outrage potential of two key stakeholder groups. Journal of Business Finance & Accounting, 45(5-6), 651-685.
Carpenter, J., & Yermack, D. (Eds.). (1999). Executive compensation and shareholder value: theory and evidence. Springer Science & Business Media.
Girous, G. (2014). Executive compensation: Accounting and economic issues. Business Expert Press.
Eklund, M. A. (2020). The holistic framework for the economically and socially fair CEO compensation. In Corporate governance: Examining key challenges and perspectives, 48.
Eklund, M. A. (2019). Fairness of CEO compensation: A multi-faceted and multi-cultural framework to structure executive pay. Springer Nature.
Kennedy, R. G. (2005). Review of “Pay without performance: The unfulfilled promise of executive compensation” by Lucian Bebchuk and Jesse Fried. Journal of Markets & Morality, 8(1), 142-145.
Rodgers, W., & Gago, S. (2003). A model capturing ethics and executive compensation. Journal of Business Ethics, 48(2), 189-202.
Ronquillo, J. C., Miller, A., & Drury, I. (2017). Trends in non-profit employment. In The non-profit human resource management handbook: From theory to practice, 29-43.
Schneider, P. J. (2013). The Managerial Power Theory of executive compensation. Journal of Financial Service Professionals, 67(3), 1-15.
Selden, S. C. (2017). Compensation practices in non-profit organizations. In The non-profit human resource management handbook: From theory to practice, 142-160.
Wade, J. B., O’Reilly III, C. A., & Pollock, T. G. (2006). Overpaid CEOs and underpaid managers: Fairness and executive compensation. Organization Science, 17(5), 527-544.