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Monday, August 25, 2014

Evaluation of executive compensation

Executive salaries compared to average Americans
Higher executive compensation does not always increase corporate performance

Limiting executive pay by law is controversial and reflects a conflict between notions of regulatory reach and commercial practices. Currently, corporate compensation is considered a business decision by the Securities and Exchange Commission (SEC). However, performance based corporate compensation data must be disclosed by law such as Section 953 of the Dodd-Frank Wall Street Reform and Consumer Protection Act otherwise referred to as the Dodd-Frank Act. In theory, it is against the principles of capitalism to limit executive pay; however, the point at which corporate dysfunction is perpetuated by individual gain is hotly debated.

The financial asymmetry evident in some executive salaries is thought by some to be abusive of shareholder interests. For example, Tom Hutchison of the Motley Fool quotes The American Federation of Labor and Congress of Industrial Organizations (AFL-CIO) as stating when incumbent Chief Executive Officers chair their own Board of Directors, an inherent conflict of interest arises out of the process. Moreover, since Boards of Directors represent shareholder interests, their selection process is not necessarily conducive to the financial goals of a businesses. Nevertheless, the American Accounting Association cites research claiming that institutional investor panels concerning executive pay lower compensation by $2.3 million.

CEO pay raises
CEO pay in excess of worker production can lower ROI
In defense of executives, commentators at the Harvard Business Review state various positions on the matter. Some say the issue of executive pay detracts from the issue of who is hired, how they get paid, and what they do to contribute to corporate success. Another implies a talent vacuum could form if executives fear a persecution of sorts, or stated otherwise, have their accountability questioned. Still another claims good CEOs are not paid enough. In any case, there are valid reasons why limiting executive pay by law is not necessarily the best option to a public, shareholder and regulatory concern.

The Dodd-Frank Act addresses some of these concerns via disclosure regulation, but performance based compensation already existed before that legislation was passed as evident in a report to the Senate Committee on Finance. So a question becomes how effective is the existence of performance based compensation if it inherently ameliorates the concerns about excessive executive pay, yet the issue remains. This discrepancy is highlighted by a report published by the Wall Street Journal that finds performance-based compensation does not actually lead to positive business performance.

Executives are responsible for leading a business to success, but they are not omnipotent money machines either. In some cases, the public and shareholders find themselves at odds with a catch-22 that leads to non-performance with compensation, and non-performance with less of it. Increases in income disparity, and concerns about the effectiveness of corporate governance fuel the debate, but so far the law has not managed to stem the controversy. Often, businesses that are not well managed, have poor earnings growth and declining share values lead to executive resignations or turnover anyway. In this sense the market economy takes care of business over time without the help of regulations.

Image license: BoogaLouie, CC BY-SA 3.0; 2. BoogaLouie, US-PD