The Golden Parachute: Why Current CEO Compensation in America is Unjustified

Now that the presidential election has passed and the future Commander in Chief of the United States is known, attention has shifted from the promises of change in the future to fixing the country’s deteriorating economy. One of the biggest issues that have elicited cries of outrage is the topic of CEO compensation in public companies, especially the ones that have been failing during this financial crisis. For example, Richard Fuld, former chief executive of Lehman Brothers Holdings Inc. received $484 million in compensation from 2000 until it filed for bankruptcy in September. Similar payouts have been recorded at other failed institutions like AIG and Countrywide. Considering that those individuals led their companies to failure, the question must be raised as to whether or not these CEOs are deserving of the outrageous pay packages they are given. Is it necessary to pay the top men in Corporate America tens or hundreds of millions of dollars in salary, stock, and other benefits? Additionally, is it fair that their bonus packages are often not directly linked to the performance of their company’s stock? When I started my research for this post, I was of the belief that CEO compensation in America is mostly justified, except for the extreme cases like Lehman Brothers and Countrywide. However, the more I looked into the topic, the more I came to believe the opposite. Except for certain cases where a CEO significantly increases the value of a company’s stock, the current level of pay for CEOs in America is not justified, for the amount of value they add to it is exceeded by their cost of services.

For most employees in the world, the amount of money and other benefits they are given for their work is directly correlated to their performance and the value they add to their employers. Recently in America, it seems that CEOs of large public companies have become exempt from that policy. One of the responsibilities of a CEO is to maximize value for shareholders. The problem has been that, looking at some of the highest earning CEOs in 2007, their pay is an unjustifiably large percentage of the company's earnings (see below, left). For those institutions that do link executive income to performance, they have developed too narrow of a focus on earnings. As Leo Hindery, Jr. observes in BusinessWeek, “from the end of World War II until the mid 1990s, prominent public and private company CEOs almost universally viewed their responsibilities as being equally split among shareholders, employees, customers, and the nation.” However, as time passed and companies became less regulated and their owners more greedy, shareholders became the most important. Hindery also points out that “at that point, because of the prevalence of stock option and restricted stock grants, shareholders included many if not most senior managers at a large number of publicly traded companies.” The problem that arises when the focus of a company turns towards making a profit and not towards accountability and responsibility is that encourages short-term profiteering and long-term irresponsibility, the American Federation of Labor and Congress of Industrial Organizations argues in an article entitled “Why the Mortgage Crisis Matters”. This attitude lead to the use of the complex financial instruments that produced large short-term gains, but in the end, is at the root of the credit crisis our country is suffering from right now.

In addition to being unjustified, bad for the company, and unhealthy for the economy, giving CEOs these huge salaries and stock options with even larger severance packages only grows the gap between the rich and the poor. On average, during 2007, average CEO pay was 344 times that of an average worker in the United States. Hindery points out that in other industrialized nations like Britain, Canada, and Japan, that multiple drops to 22, 20, and 11, respectively. What is it about the average CEO that makes him or her hundreds of times more important to a company than its average employee? Would the average CEO be more useful to a company than an additional 344 employees? Freek Vermeulen discusses how the boards of directors in these companies (the people who determine how much a CEO makes) use a comparison to a company’s “peer group” to justify the number they choose. Unfortunately, the problem with this logic is that the overcompensation of executives is system wide. It is a rare instance when the head of a company is not making at least upper seven digits. In reality, there are only a handful of individuals who are actually worth the kind of money CEOs are being given today. They are the Warren Buffet’s and the Jack Welch’s of the world. They are the people who, if the company were to lose them, they would potentially lose billions of dollars of value. The average CEO is not that person. He or she is skilled or intelligent, but there are many skilled and intelligent people in the world. The only difference between the two groups is that one is being paid millions and millions of dollars, while the other may be making little over what the average worker makes. I see that as a cruel injustice which polarizes our society and harms our economy. It must be changed.

Luckily, executive compensation has become a top issue in our government today. Considering the fact that the United States government is making hundreds of billions of dollars available to these companies, it absolutely should be an issue. Taxpayers should not be the ones supporting the lavish lifestyles of the people who caused the economic downturn in the first place (see right). Unfortunately, the current bailout package has loopholes in it that would allow this spending to continue unchecked, a fact which some legislators have not overlooked. They are calling for caps on CEOs salaries if they receive money from the bailout. While the bailout is a special situation, I think that there should be broader changes across the market. Stockholders, not a board of directors, should be the ones who determine how much a company’s executive makes. They are the ones who stand to make or lose money depending on how the company performs, and so they are more likely to reward smart, sustainable decisions. There may be better ways to remedy this issue, but the fact of the matter is that the amount CEOs of American companies make is excessive, and as such, is a problem. It is a detriment to the growth of a company and disease that, if allowed to continue, will keep our economy from truly regaining its health.