Corporate Governance: Executive Compensation

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Corporate Governance Research Paper
Trends in Executive Compensation
Oct.10, 2013

Introduction
Top managers of firms are under scrutiny from the public due to what seem to be high salaries, bonuses and stock options. There have been definite trends in regards to executive compensation, and they all tend to lead to higher compensation of executives over time. There wasn’t always transparency in regards to executive compensation, but due to government and public pressure, companies are clearer about the compensation packages that are being given to their top executives. With recent unemployment in the US and executive scandals, the public is growing more concerned with, what seem to be, exorbitant compensation packages. There could be legitimate reasons for high compensation such as performance benefits, retention of talent, and aligning the officer’s interests with the owners, while avoiding moral hazard. There are other theories that could be reasons for high pay such as agency theory and tournament theory. All of these reasons have common criticisms which will be looked at. Issues

Starting in the 1960s there was a noticeable trend of an increase in benefits to executives. From 1965-66 the average CEOs pay for the top 489 companies rose by 5.8% from the previous year, and had steadily been increasing for the five years leading up to 1966 (Patton, Lack. 1967, p. 22). The sixties were nicknamed “the soaring sixties” because from 1960-66, according to Patton, Lack. (1967. P. 24), the average company’s sales doubled and profits rose by over 70%. Executive compensation packages then followed suit with increases. According to Patton, Lack. (1967. P.24), historical data shows that doubling the size of a company should be followed with a 20% increase in pay due to more responsibility, and that the executives were actually taking smaller amounts for themselves. The relationship here was based on sales performance and not profits, where a company’s size was being based on sales. This explains why there was an increase in compensation to executives, but not to the degree of profits. A large portion of compensation in the US and internationally was made through bonuses; managing directors reported that on average 25% of their salary was through bonuses. The major factors in the uptrend of compensation were the cost of living and company growth (Patton, Lack. 1967). This information can link compensation with company performance, which is still one of the leading factors of executive compensation. In 1980, a corporate CEO was making 40 times what the average worker made in the US and by the year 2000, that number went to 400 times the average workers yearly earnings (Bruvik, Gibson. 2011. P. 69). It is no wonder that the public has been so angry about what is seen as the over compensation of corporate executives. There are a couple theories that are out there as to why such enormous packages are given out though. Agency theory is the first theory described. It states that the CEO is essentially an agent for the company owners and shareholders. According to Wasserman `` Per agency theory, self-interested agents take actions inconsistent with the best interests of their organization’s shareholders when doing so is possible and serves the agents’ self-interest. The more divergent the interests of agents and principals, the greater the agency costs`` (as cited in Bruvik, Gibson. 2011. P. 71). Which means that the compensation for the CEO has to be great enough to align their personal goals with that of the shareholders best interest. Although simply putting pressure on a CEO to perform and monitoring the performance is logical, there is a back side to this too. According to Hoskisson, Castleton, & Withers, the increased pressure put on a CEO leads them to demand more compensation to make up for the stress of monitoring (as cited in Bruvik, Gibson. 2011). Another theory analyzed is tournament theory, where...
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