The Benefits and Pay of Being an Executive

Recent corporate scandals at large firms such as Enron and WorldCom have forced many investors to reconsider the specific level of trust that they place in those of authority in the organization. In particular, the problems created by the scandals have prompted many individuals to consider the specific methods that organizations utilize to develop pay and benefits for executives in the organization. At a time when investors are losing money and employees are losing overtime and healthcare benefits, it seems as if corporate executives are making more money than ever. Despite the fact that notable attention has been given to this issue, considerable obfuscation over why executive compensation remains so high continues to exist.

With the realization that executive pay and benefits are significantly high when compared to what average employees make, it becomes evident that there is a direct impetus to consider why this is so. Utilizing this as a basis for research, this investigation considers what has been written about the development of pay and benefits scales for executives in the organization. Given the negative attitudes that continue to pervade modern perception of executive pay and benefits packages, examination of this issue should provide some clarity as to whether or not executives are overpaid for their contribution to the organization. Further, through a careful consideration of what has been written on the subject it will be possible to provide more insight into understanding of how pay and benefit packages are determined for the corporate executive. With this information, a more integral understanding of both the contribution of the executive to the organization and the development of pay and benefit packages will be gleaned.

Executive Pay and Benefits-An Overview

Reviewing what has been written about the issue of executive compensation, the research clearly demonstrates that most individuals believe executives are overcompensated for their contribution to the organization. For instance, Gomez-Mejia and Wiseman (1997) argue that executive pay and compensation levels have been widely debated over the course of the last 75 years. Although organizations continue to claim that the development of pay and benefits scales are directly linked to the performance of the organization-which is a clear indication of how well the executive is doing his or her job-statistical research which supports this hypothesis has not been widely provided in the literature. Gomez-Mejia and Wiseman go so far as to argue that much of what has been written about the link between executive pay and organizational performance is predicated more upon anecdote than actual data. Thus, it is not surprising to find that individuals examining the context of executive compensation packages would be unsatisfied with the data that has been presented.

Schiehll (2005) in his review of public perception of executive compensation packages notes that, "executive compensation has surfaced as a highly polarizing issue in corporate governance. Terms like 'excessive' and 'abuses' are used to describe compensation plans that seem at least two outsiders to reward top management while the companies they serve remain unprofitable" (p. 38). Although organizations claim that executive compensation packages are closely tied to the performance of the organization, investors are now calling for specific measures which definitively demonstrate how executive compensation can be directly linked to the development of shareholder wealth. In other words, investors are seeking a new method of executive compensation that is directly tied to the profits that are generated by the organization. In this context, it becomes clear that the umbrella of "performance" that is typically utilized for the development of compensation packages is much broader than the financial performance of the organization. In this context, performance refers to a wide range of issues that may or may not be linked to the financial development of the organization.

The inability of individuals and investors to accurately understand the development of executive compensation packages can clearly be understood given the extent of these packages and the overall issue of organizational performance. Specifically, Colvin (2005) notes that when Carly Fiorina left Hewlett-Packard she took with her a $42 million exit package. This compensation was a negotiated part of her contract with the organization. Although researchers examining executive compensation packages argue that these packages are directly linked to the performance of the organization, over the course of the last three years Hewlett-Packard has consistently lost share value. What this effectively suggests is that Fiorina's salary and benefits could not have been based upon the financial performance of the Hewlett-Packard organization. Rather, as the organization continued to lose money Fiorina's salary and benefits continue to grow. Even after being ousted from the organization, Fiorina's was able to take with her a considerable amount of money that could have been utilized to boost the overall profits of the organization and investor wealth.

When placed in this perspective, it becomes evident that executive pay and compensation packages have to be predicated upon something other than the financial performance of the organization. Over the course of the last five years, the financial performance of most organizations has declined notably. Despite this however executive compensation has continued to rise steadily. With this in mind, the question then becomes: "How can organizations effectively justify the executive compensation packages that they provide to their top leaders?" Interestingly, the research continues to support the theory that executive compensation is directly linked to the performance of the organization. However, as more criticism of this theory begins to emerge researchers are now examining all of the specific variables that can contribute to the development of executive pay and benefit packages. Utilizing this as a basis for further investigation, it is now possible to consider the specific underlying variables that often contribute to the creation of such extravagant executive pay and benefit packages.

Developing Executive Pay and Benefit Packages

Attempting to explicate the specific "performance measures" that are utilized by the organization to develop executive compensation packages Schiehll (2005) makes the following observations:

Boards of directors and their compensation committees must ensure executive incentive programs are effective. To do so, they should consider the multiple objectives that must be linked to performance contingent compensation and assess firm performance from multiple perspectives such a short-term versus long-term, processes versus output, and financial versus non-financial. Clearly, effective incentive designed depends on the choice of performance measures (p. 38-9).

To achieve these goals, Schiehll goes on to provide an overview of the specific performance-based standards and organizations utilize to develop executive compensation packages. Among the most notable standards that are utilized are the following:

- Budget Performance Standards - In many cases executives are assessed based on their ability to adhere to the financial constraints placed upon them in the organization. Because the budget is set by the organization and not by chief executives, the ability of the executive to adhere to a budget is an issue of principle concern with the organization.

- Prior Year Standards - Executive compensation is often predicated upon the ability of the executive to move the organization forward. As such, the specific actions taken by the executive are compared to those undertaken in previous years. The outcomes of these actions are assessed to discern if progress has been made in the development of the organization as a whole.

- Peer Group Standards - Schiehll argues that to remain competitive most organizations have to offer pay and benefit packages that are commensurate with other organizations in the same industry. As such, executive pay and compensation is often predicated upon what others in the same industry are being paid for their services.

- Timeless Standards - Timeless standards refer to specific objectives developed by the organization to ensure forward progress over a number of years. For instance, the organization may seek to increase revenues 10% each year for a total of 10 years. This 10% increase remains in place independent of actual performance.

- Discretionary Standards - "Discretionary standards include plans for performance where goals are set subjectively by the Board of Directors following a review of the company's business plan, prior-year performance, budgeted performance, or a subjective evaluation of the difficulty in achieving budgeted performance" (p. 39). In this context, the Board of Directors is given some degree of leeway in determining what is appropriate for the overall development of the organization.

Other authors looking at the specific variables that are utilized in determining executive compensation make the observation that in many cases the problems that arise in the context of public perception of executive compensation as excessive stem from the fact that most investors believe that executive compensation is, or should be, directly related to the financial success of the firm. However, in most cases the specific compensation package that is developed for the executive is predicated upon a wider range of variables that consider the overall development of the corporation. This includes variables that lie outside of the realm of the financial performance of the organization (Anson, White, McGrew & Butler, 2004). In particular, Anson, et al., (2004) make the observation that executive compensation packages are often predicated upon the ability of the executive to achieve or maintain the mission of the organization. In this context, the specific amount of money that is generated for shareholders is not a principal issue for developing the executive compensation package. Rather what becomes important in this situation is the ability of the executive to fulfill the mission of the organization.

Additionally, researchers have also noted that the notable criticisms that have developed over perceived excessiveness in executive compensation packages have forced many organizations to redesign how they allocate pay and benefits for top executives. In particular, Wyatt-Johnson, Bennett, and Hatchett (2004) argue that in many organizations executive compensation packages are structured such that base salary and benefits are paid regardless of the financial performance of the organization. In addition, stock options, bonuses and other incentives are added to the contract as a means to facilitate the financial growth of the organization. In other words, if the executive is able to improve the financial performance of the organization he or she will receive additional compensation that reflects this achievement. If the executive fails to improve the financial performance of the organization he or she will be ineligible for certain incentive programs. In spite of the fact that these new executive compensation packages have provided some degree of appeasement for critics, there is still considerable controversy over the large sums of money that executives are paid as a matter of their "base salary."

Despite the controversy over, what are perceived to be, high base salaries, researchers have noted that in most cases, organizations are able to provide sound justification for their decisions. To illustrate this point, one author examining the development of base salaries in the healthcare industry makes the following observations about how base salaries are determined in this industry:

Base salaries will be set within the range from the market percentiles of base salaries for comparable positions at similarly situated organizations. The competitiveness of executives' base salary is reviewed on an annual basis, and adjustments are made when market conditions warrant and financial performance allows. The size of the adjustment will be based on the executive's experience, performance, and contribution to [the organizations] performance, as well as on the competitiveness of the executive salary within the marketplace (Sample executive..., 2004, p. 27).

What this effectively suggests is that the base salary of the executive is predicated upon a number of factors, chief among which is the issue of how other professionals in the same industry are compensated for their services.

Further examining the issue of base pay in the context of executive compensation, Higgins (2005) also asserts that the need to create equity with regard to all executives in the same industry is one that is of paramount concern for most organizations. According to this author, base salaries for executives are predicated upon the need to attract and retain qualified individuals. In many industries, there are declines in the number of individuals qualified to fill executive roles. As such, in order to remain competitive organizations must offer significant benefit packages to attract the leadership necessary to facilitate the growth and development of the organization. Without attractive compensation packages, organizations will have difficulty attracting qualified individuals. When this occurs the organization will remain at a deficit because it does not have the leadership that it needs to improve its operations.

Although there is a considerable amount of logic behind the idea of the utilizing pay and benefit packages as a means to attract and retain qualified executives, it is also clear that this process creates a cyclical problem for the development of executive compensation packages. For instance, assume that executive base pay is set at a specific level in the healthcare industry. A chief competitor in this industry loses its top executive. In order to attract qualified, experienced candidates the organization chooses to raise the level of executive pay that is standard in the healthcare industry. Clearly, with a better executive compensation package the organization will be able to find and retain a qualified professional for this position. However, this process effectively raises the bar for what is acceptable in terms of executive compensation in the healthcare industry. Hence, when another organization loses its chief executive this organization will have no choice but to either match or exceed the new compensation limits that have been previously established in the industry. If competition for qualified executives in a give industry is high, executive compensation packages can become artificially inflated based solely on competition.

The issue of industry standards aside McCallum (1998) argues that in most cases the specific executive compensation packages that are created by the organization are appropriate given the magnitude of the services rendered by executives. According to this author, "The job of the executive of a corporation and especially its chief executive officer, is to develop the enterprise's vision, pull together, co-ordinate and monitor the people, financial capital, hard assets and plans needed to achieve that vision and to provide for orderly succession so the enterprise can endure and flourish beyond the current executive's tenure" in this context the executive is responsible for the "survival, growth, prosperity and continuity of the enterprise" (p. 65). McCallum goes on to argue that it is not just the organization or its employees and shareholders that should be beholden to the executive of the organization. This author asserts that a society as a whole has an obligation to support executives by offering them significant compensation to keep the economy from collapsing. In short, McCallum believes that executives are a critical component of the development of the economy: "The corporation is the dominant form of business organization in our economy. [...] How corporate leaders are compensated is, therefore, of consequence far beyond the leaders themselves and their enterprises. It affects the whole economy and everyone who derives their standard of living from it" (p. 65).

When placed in this context, it becomes evident that the role of the executive is one that should not be taken for granted by shareholders. As noted by McCallum executives provide a valuable service for the development of the economy and for the financial stability of most individuals in society. Although it is clear that exulting executives to such a substantial level in social discourse is not necessary, the points made by this author are well taken. Executives are responsible for the successful operation of the organization. If organizations did not have these leaders, they would be unable to effectively perform their jobs. Without successful organizations, society would not have a sustainable source of employment and financial development. With this in mind, McCallum believes that this reality, in and of itself, should be used to justify executive compensation. While it is clear that the executive assumes a notable role in the overall development of economics, this issue does not warrant the excessive compensation that is typically utilized to retain qualified professionals.

In an attempt to frame the issue of executive compensation in another light, McCallum also makes the following argument, "Five hundred thousand to C$2.0 million is not chicken-feed. But it pales, for example, beside the combined salary/winnings of some professional athletes... [...] Entertainer compensation can be even more spectacular" (p. 66). Overall, what McCallum elucidate is the fact that society supports high levels of compensation for various individuals that contribute relatively small amounts to the overall economy. In this context, McCallum argues that the specific levels of executive compensation that are currently offered are justifiable based on what these individuals give back to both the organization and to society as a whole.

Synthesis and Comment on the Research

Synthesizing all of the information that has been presented in this investigation, it becomes evident that when organizations develop pay and benefit packages for executives they must consider a wide range of variables in doing so. What appears to cause the most obfuscation for investors and other organizational stakeholders is the umbrella term of "performance" that is typically utilized to justify the pay and benefits packages given to executives. Clearly, what this research elucidates is that the specific measures of performance that are utilized for developing executive compensation packages are much more complex than what the average investor understands. In most cases, investors assume that the "performance" that is utilized for executive compensation is that which is directly tied to the financial development of the organization. While it is true that parts of the executive compensation package are intricately linked to the financial development of the organization, for the most part other issues of organizational performance are associated with the development of the executive compensation package as well. As such, it becomes evident that one of the most pervasive problems with regard to the issue of executive compensation is not the compensation in itself, but rather public perception of what executive compensation should be theoretically linked to in all cases.

Reviewing what has been written about public perception of executive compensation packages, it becomes evident that most investors and individuals believe that there is a direct link between executive compensation packages and the greed that has recently been exhibited by executives involved in corporate scandals. To illustrate this point Vosper (2004) makes the following observations:

Some observers believe that outlandishly high executive compensation packages were the root cause of the scandals that recently befell so many high profile companies. They argue that executive compensation got so out of hand in the late 1990s, it created a business culture of greed, and led to a class of executives who were so obsessed with stock prices they were willing to go to great lengths to hide financial losses (p. 32).

Thus, the development of corporate scandals has left many investors to argue that the use of executive compensation packages will only continue to contribute to the downward spiral of the organization. As executive compensation packages continue to increase, society will witness notable increases in the financial corruption that is associated with organizations.

Interestingly, although public criticism of, what are viewed as, excessive executive compensation packages have not had much impact on the development of these benefits in the past, researchers now note that public scrutiny has prompted many organizations to re-examine the specific measures that they utilize to determine executive pay and compensation. As a direct result of this process, researchers report that substantial reductions in executive compensation packages are being undertaken. Further, these authors note that many organizations are moving toward a system of full disclosure in which all aspects of executive compensation are disclosed to the public. This process requires that each part of executive compensation is linked to some direct facet of organizational development. Researchers argue that by utilizing these methods of disclosure, the public will garner a better sense of the specific duties performed by the executive and how the organization links these duties to the issue of pay and benefits (Snavely, 2003).

Conclusion

In spite of the recent changes that have taken place within the context of reducing executive compensation and providing the public with more insight into this process, it is evident that the public still believes that executive compensation packages are excessive. Utilizing the information that has been presented here, it becomes clear that the organization uses a complex process for developing executive pay and benefit packages. The question that still remains however is whether or not these packages can be justified given the specific dimensions of organizational performance that have been outlined in this investigation. Clearly, the executive plays an integral role in the continued development and success of the organization. This process takes place on a number of levels that often do not include the financial performance of the organization. Regardless of this realization, it seems feasible to argue that the pay and benefit packages that are created for executive are still excessive overall.

Seeking to discern what can be done to better justify the development of executive compensation packages, it becomes clear that the recent decision of some organizations to provide detailed information about how executive compensation is linked to specific aspects of organizational performance will provide notable insights for investors and laymen alike. With a clear understanding of how the performance of the executive is linked to his or her compensation, investors and laymen will be able to make clear judgments about whether or not such extensive compensation is warranted. Without this information, the development of executive compensation packages will remain shrouded in secrecy and continue to foster resentment on the part of investors. Given the importance of investors to the organization, it is clear that maintaining investor confidence is a key issue for the continued success of the organization.

In the end, it is clear that if organizations are to meet the needs of all stakeholders and shareholders information on how executive compensation packages are developed will be necessary for achieving this end. Executive compensation has become such a contentious issue that if steps are not taken by the organization to mitigate this tension, notable problems may develop in the long-term. Unfortunately, the development of executive compensation packages has been shrouded in so much secrecy that even the most observant of investors can have difficulty discerning the specific methods used for creating these packages. While it is reasonable to assume that each organization will have a notably different method for creating executive compensation packages, it is clear that organizations must provide this information in order to continue to justify paying executives such large salaries. Organizations that fail to provide this information may witness a decrease in investment as investor confidence begins to decline. As more organizations elucidate their specific methods for determining executive pay and benefits, this will serve as the impetus to place more pressure on organizations that do not provide this information. As such it is clear that the evolution of this issue is one that will remain ongoing for a number of years to come. In other words, public understanding of executive compensation packages will continue to develop over the long-term.

References

Anson, M., White, R.T., McGrew, W., & Butler, B. (2004). Fair or excessive? A reliable model for determining the appropriateness of executive compensation. Ivey Business Journal, 68(5), 1-8.

Colvin, G. (2005). Outraged over CEO exit packages? You're too late. Fortune, 151(5), 62.

Gomez-Mejia, L., & Wiseman, R.M. (1997). Reframing executive compensation: An assessment and outlook. Journal of Management, 23(3), 291-375.

Higgins, K.T. (2005). A transparent legacy. Marketing Management, 14(2), 18-21.

McCallum, J. (1998). Executive compensation: Important issue. Ivey Business Journal, 63(2), 65-68.

Sample executive compensation philosophy. (2004). Trustee, 57(7), 23.

Schiehll, E. (2005). Executive compensation disclosure. CMA Management, 79(4), 37-40.

Snavely, B. (2003). Executive compensation Sea change. Crain's Detroit Business, 19(21), 11-13.

Vosper, R. (2004). Executive compensation gets an extreme makeover. Corporate Legal Times, 14(148), 32-33.

Wyatt-Johnson, C., Bennett, C.J., & Hatchett, B.L. (2004). Calibrating executive compensation. Trustee, 57(3), 12-20.