Top Management’s Pay Increase in a Failing Organization

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Abstract

U.S. corporations have come under heavy criticism in the recent past due to their top executive compensation schemes. This has been especially in light of the recent financial crises which have resulted in companies failing while CEOs and company top management continue to enjoy high pay. This paper advances that the current practice by top executives accepting high payouts is ethical since this managers not only act in the best interest of the shareholders but they also personally shoulder the blame when companies fail. The high payout given to top management shall therefore be demonstrated to be justifiable and ethical as long as managers engage in dealings without deception or fraud.

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Introduction

Over the course of the past three decades, there has been a trend by big United States corporations to offer extravagant pay packages for their CEOs and other top company executives. Bergstresse and Philippon (2005) confirm that the firms which engage in this practice have justified the practice as being a means through which “upper management incentives are aligned with the interests of shareholders”. While the public previously showed little concern regarding this practice, the financial meltdown of 2008 that resulted in the near-crash of the U.S economy resulted in a critical look at the top executive earnings. This was catalyzed by the widely held perception that top risky behavior by top executives was responsible for the financial crises. In addition to this, the top executives continue to enjoy enviable remuneration even in light of the bleak financial realities that the rest of the country faces.

For this reasons, there has been public outcry for the government to intervene and come up with means of regulating the conduct of companies as with regard to their top executive compensation schemes. The question as to the ethical soundness of the practice of giving large pay increases to CEOs and upper management even when the company is unprofitable or even at the brink of insolvency has also been raised. This paper shall argue that it is ethical for company executives to accept large pay increases as long as they do not engage in illegitimate practices to obtain the benefits. The paper shall demonstrate that the top executives deserve their pay and in a capitalistic environment where ones efforts are rewarded accordingly, this is ethically sound.

Role of Top Executives in Companies

Throughout their existence, organizations and businesses are considerably pressured to raise their levels of performance and productivity. This is especially so in the modern day business environment which is characterized by aggression and excessive competition thereby constantly forcing businesses to exhibit innovation and enhanced performance to remain relevant and profitable in the ever increasingly competitive arena. The function of management is especially significant to the success of the organization since this is the people taxed with marshalling the human resource in the organization for its growth and expansion is therefore crucial.

According to Holmstron and Kaplan (2003), before the 1980s managers in large public U.S. corporations had little reasons to make shareholder interests their primary focus since these managers felt themselves to be representatives of the “corporation” and not the shareholders. As such, they did not aim at maximizing shareholder wealth but rather ensuring the growth and stability of the organization as a whole. Therefore, to ensure that top managers were highly motivated to achieve organizational objectives and especially increase the profit margins of the shareholders, companies began offering huge pay and bonus packages to the upper management. This practice paid off since managers were now inclined to achieve maximum profits since their financial wellbeing was tied to the same.

An Ethical Perspective

Ethics can loosely be defined as a system of moral principles by which social conduct is judged as either “right” or “wrong”. As relates to business, ethics are moral principles which prescribe what is legitimate behavior in varied business dealings (Chryssides & Kaler, 1993, p.3). An interesting concept with regard to ethics is that there is no standardized approach to dealing with ethical issues as they all spring from very unique legal, political, social and economic backgrounds. As such, there are no “uniform” ethical practices though there may be those practices that are generally accepted by the society. Coelho, McClure and Spry (2003) therefore suggest that the operative words in ethics are “without deception or fraud”.

Many people deem the high pay of company top management as unethical since the economy is seen to be failing. Holmstron and Kaplan (2003) reveal that for all the negative criticism that U.S. corporations have received over the recent years, U.S. stock markets have performed relatively better than those of the European and Pacific markets. These authors further on argue that corporate governance which was aimed at boosting productivity was responsible for the resurgence in productivity levels in the 1980s and 1990s. The fact that shareholders of U.S. companies earn high returns even after making huge payments to executives illustrates the point that top manager’s fulfill one of their core responsibilities which are to take care of the interests of the shareholders of the company.

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Certo et. al. (2005) reveals that top executives including chief executive and chief financial officers are likely to suffer from personal losses following the financial failure of their organizations. This is because one of the roles of the executive leadership in an organization is to establish and maintain the legitimacy of the organization as perceived by its stakeholders. Certo et. al (2005) assert that this is accomplished by the executives being the symbols of the organization success and failures. When the organization fails, these executives are used as scapegoats and their removal from office is seen as the organization’s conscious effort to fix the problem. Invariably, as a result of their being stigmatized and discredited, the prospects of top executives who are used as scapegoats are hurt badly. Studies have revealed that as a result of this stigmatization process that organization engages in, the effect on the top executives subsequent career is devastating as no organization of repute will want to be associated with a “failure”.

One of the theories that guide manager’s behavior in an organization is the stakeholder theory which states that “managers should make decisions to take account of the interests of all the stakeholders in the firm” (Jensen, 2001, p.299). However, stakeholder’s theory fails to stipulate how managers should go about choosing among multiple competing interests from the various stakeholders. This may therefore lead to a situation whereby self serving managers make decisions that favor them while still purporting to have the stakeholder’s interest at heart. In a situation whereby it is the top management decisions which have resulted in the negative performance of the company, it would be unethical for the managers to accept huge pay increases.

Discussion

Holmstron and Kaplan (2003, p.11) note that the increase in equity-based compensation to top executives resulted in the declaration that “the paramount duty of management and board is to the shareholder and not to other stakeholders”. This clearly illustrates that the increase in CEO pay is not out of the altruistic nature of organizations but rather is to act as an incentive for CEOs to maximize shareholder value. This being the case, it would be grossly unfair to victimize the upper management for accepting the pay since it is given to them to make them make a company even more profitable for the shareholders. If the company continues to suffer, it is usually general practice for the CEO and other top officials to be dismissed to change the public image of the company.

Invariably, there may be situations whereby the upper management may be responsible for the company’s declining profitability e.g. when top managers inflate the company’s stock value for personal gains. In such a situation, the acceptance of huge pay by top management is not only ethically wrong but also legally unacceptable. Jensen (2001) suggests that governments should create an environment whereby corporations are forced to care about their responsibility to the society and act in a manner that is not detrimental to the entire community.

The underlying assumption behind declaring the accepting of huge pay increases by top management as unethical is that they are to blame for the company’s failure. Indeed it may be that a particular company’s lack of profitability is as a result of other factors which are independent of the company’s top executives. As such, the role of the managers may be what is keeping the company away from further chaos. As such, it would be unjustifiable to blame the CEO and upper management for losses that are not of their own doing.

Conclusion

This paper set out to argue that it is ethical for CEO’s and upper management to continue enjoying large pay increases even in when the company is unprofitable so long as they do not engage in deception and fraud to achieve this huge pays. To reinforce this assertion, this paper has demonstrated that company top executives shoulder huge responsibilities on behalf of the company and have the most to lose in the event of a mistake that results in backlash against the company. Top managers are also under constant pressure to deliver to ensure the prosperity of the shareholders. In addition to this, the managers are at times not responsible for the financial realities of the company and should therefore not be blamed for the same. However, the paper has taken care to stipulate scenarios where managers are responsible for company losses and should therefore not accept huge pay. However, companies should take care to ensure that payouts to CEOs and top management remain reasonable so as not to infuriate the public and other relevant shareholders to the company.

References

Bergstresser, D., and T. Philippon. 2006. CEO Incentives and Earnings Management. Journal of Financial Economics 80 (3): 511–529.

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Certo, R. S., Arthaude-Day, M. L., Dalton, M. C. & Dalton, R.D. (2005). A changing of the Guard: Executive and Director Turnover Following Corporate Financial Restatements. Web.

Chryssides, D G & Kaler, H J 1993, An Introduction to Business Ethics. Cengage Learning EMEA.

Coelho, R. P., McClure, E. J. & Spry, A. J. (2003). The Social Responsibility of Corporate Management: A Classical Critique. American Journal of Business. Spring 2003: Vol.18. No. 1.

Holmstron, B. & Kaplan, N. S. (2001). Corporate Governance and Takeovers in the U.S.: Making Sense of the ’80s and ’90s. Journal of Economic Perspectives (2001), pp.121-144.

Holmstron, B. & Kaplan, N. S. (2003). The State of U.S. Corporate Governance: What’s Right and What’s Wrong? Web.

Jensen, M. C. (2001). Value Maximisation, Stakeholder Theory, and the Corporate Objective Function. European Financial Management, Vol. 7, No. 3, 2001, 297-371.

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BusinessEssay. "Top Management's Pay Increase in a Failing Organization." February 24, 2022. https://business-essay.com/top-managements-pay-increase-in-a-failing-organization/.