Oct 20, 2009
ECONOMIC WATCH
Executive compensation: Busting those myths

By Richard D. Arvey, For The Straits Times

EXECUTIVE pay has hit the headlines again, especially the huge salaries and bonuses being given in the financial sector.

This has occurred even in companies that received government bailout packages or are losing money. For example, Blackstone Group’s Mr Stephen Schwarzman received a staggering US$702 million (S$978 million) pay package, and nine of the biggest banks in the United States handed out US$47 billion in bonuses even as they posted losses.

Leaving aside salaries in the financial industry, there is also evidence that executives across the board are receiving large pay packages and that these have been increasing over time. Some estimates suggest that executives are now extracting about 10 per cent of profits, which is dramatically greater than in previous historical periods.

There have been quite a few arguments put forward to justify the scale of executive pay. The first is that the work now is more demanding than ever before. Not only do executives have to tend to their company, but they also have to monitor and deal with a variety of external challenges – such as security threats, climate change, epidemics, going green, going global and so on.

Few would say that these are easy tasks. But others, such as scientists and government officials, do equally challenging work – and they don’t enjoy the same level of pay.

The second argument is that executive compensation is related to company performance. However, research shows a weak link between the two. In many instances, executives are paid a great deal even when their companies do abysmally. And if company results affect pay, why aren’t other employees being similarly compensated when their companies perform well? Executives seem to be hogging the returns – when their companies do well and even when they don’t.

Consulting and recruiting firms hired to advise on executive compensations may also be adding to the problem. Such firms clearly have a vested interest in making sure the executives they recruit are paid as much as possible, for they typically receive some portion of the first year’s pay. There is evidence that pay packages are lower when consulting firms are not involved in the negotiations.

Another argument advanced to explain high executive pay is the supposed shortage of talent. To prevent executives from jumping ship, companies are forced to make it worth their while to stay.

This is true for a small set of exceptional individuals but there are many executives looking for jobs. In a PricewaterhouseCoopers survey conducted recently, it was reported that ‘companies operating in the Asia-Pacific private banking market will cut their recruitment of wealth management advisers by 17 per cent over the next two years’. This implies that there would be many people who would gladly take these jobs, even if they are paid less than exorbitant sums.

Yet another argument goes that executives are at risk of losing their jobs and, therefore, need greater levels of compensation to induce them to join the company. While there are signs that the tenure cycle for executives is indeed getting shorter, people in other professions are at equal, if not greater, risk of losing their jobs.

Then there are the psychological arguments, the first being that it is necessary to pay executives a lot in order to motivate them. However, there is no evidence to suggest that US$100 million would motivate an executive more than, say, US$10 million.

The second is that executives have come to feel a sense of entitlement. The notion is that executives have distinguished themselves from everybody else in society and should, therefore, be compensated accordingly. In other words, pay packages are a measure of status. Society has contributed to this point of view by romanticising executives and treating them like gods, especially in the US.

Governments – particularly those in Europe – have begun to examine executive pay packages and put caps on them. Firms too are starting to restructure pay packages, placing a greater emphasis on long-term rather than short-term performance. Clawback clauses are also being introduced to recover money from executives who were paid excessively.

In addition, there are increasing calls for executives to consider the well-being of others in their firms instead of focusing on just their interests. But there is resistance to such reforms and it will take time to put them into effect.

The writer is head of the department of management and organisation at the NUS Business School

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