Executive Compensation : Ethical Issues

Presented by :- Group 10

Agenda Introduction Executive compensation over the years Is executive compensation at current levels

justified Analysis through stakeholder’s perspective Indian context Analysis through various theories. Case Study Conclusion & Recommendations

“The culture of excess greed, excess compensation, and excess risk has to change”

“resist excessive remuneration to promoters and senior executives and discourage conspicuous consumption.”

Executive Compensation over the years

1980: CEO pay documented at 30-40 times of an average worker

• This led to regulations initiated by SEC which required compensation of 5 highest paid executives to be made public.• Intention was to make the process transparent & performance-driven.• In reality since the data was out in the open it led to increase in executive compensation.

2000: Exec comp ended up being around 500-600 times those of an average worker in the company.

2008: Current levels at around 300 times .

Average CEO to Average Worker Pay Ratio

1980 1990 2000 2006 2007 20080

2

4

6

8

10

12

So is high executive compensation justified?

CEO compensation levels in 2008

Name Company Compensation

Stephen Schwarzman Blackstone Group $702,440,573

Lawrence Ellison Oracle Corp. $556,976,600

Ray Irani Occidental Petroleum Corp.

$222,639,705

John Hess Hess Corp. $159,566,940

Michael Watford Ultra Petroleum Corp. $116,929,392

Bob SimpsonChesapeake Energy Corp. $114,286,867

Mark Papa XTO Energy Inc. $103,485,972

Eugene Isenberg EOG Resources, Inc. $90,471,784

Aubrey McClendon Nabors Industries Ltd. $79,333,079

Michael JeffriesAbercrombie & Fitch Co. $71,795,744

Both sides of the argument

Justified Not Justified The executive compensation has increased with

the market capitalisation of these large companies.

As businesses are becoming more and more complex the demand for top executives is increasing and they are commanding greater pay.

CEOs made up only about 3% of the people with the top 0.1% of U.S. adjusted gross income in 2004-2005, a fraction that was little changed from a decade earlier.

Take home pay for CEOs is strongly related to performance.

The compensation of the CEOs of most of the big companies is set by independent directors.

Executives have greater incentives to protect their credibility and ensure the long-term value of equity and the sustained growth of the company.

Executive compensation should be regulated because executives are trying to maximize their returns rather than those of the shareholders’ whom they represent

Even though the compensation of the CEOs and other executives are set by separate independent directors, it is true that those people are able to influence them.

Studies showing that the return on investment from these pay packages is very poor compared to other outlays of corporate resources.

Obscene amounts of money paid to CEOs when the world is undergoing recession is not justified

Minimum shareholder’s say in the process.

Key Stakeholders

Company Shareholders

Government Society

Stakeholder’s Perspective

• Compensation paid to executives is mostly a factor of performance.• Nobody wants to be below the median and lose the talent to

competition.• Regulations set by SEC on executive compensation are met year after

year.Company

• Currently have indirect say in deciding executive compensation.• Obviously want the best executives to lead the company and

recognises the fact that they have to be paid well • But also demands that the pay be strictly performance based.

Shareholders

•The governments across the world have been accused of being too soft on the corporate world on this issue.•They have also been accused of colliding with them and giving them various tax-breaks, options for deferred compensation, e.t.c.•Since the recent recession the governments across the world have become far more stricter on the issue .

Government

•The society sees the whole issue executive compensation as having moral connotations.•Regular working people have lost half of their 401ks in America, and many have lost their jobs, only to see over-the-top bonuses paid out to those responsible for the mess•Lucent Technologies in fact reported a $17 billion loss and sacked 56,000 workers. Then it gave its CEO a $22 million payoff Society

CEO Compensation – Indian Context Most Indian companies family enterprises. As a result determination of pay is arbitrary and

also there is very little regulation Presently, the average package of the top five

Indian CEOs is around Rs.31.8 crores. In India, the ILO reports that labour productivity

shot up 84 per cent between 1990 and 2002. But real wages in manufacturing fell 22 per cent in the same period.

This was also a period when CEO salaries had begun clocking all-time records. Even now, top-end compensations in India are growing much faster than in the U.S.

CEO Compensation – Indian Context When Manmohan Singh asked India Inc. to

take pay cuts there was outrage in the media. The issue is even more relevant in the Indian

context given the levels of inequality in our country.

However what is missing in India is the public debate that is happening in the U.S.

Media that is becoming less and less socially relevant & is interested in trivia than news.

Analysis through the theories of ethics

Utilitarianism The greatest good for the greatest number of

people An action is right if and only if it produces the

greatest balance of pleasure over pain for everyone CEO compensation derived from those willing to

offer recourses of such grand magnitude and controversy

Corporations who perform poorly yet continue to reward their CEOs acting in direct contrast to the utilitarian concept

Corporate stakeholders: Shareholders, board of directors,

employees, consumer

Contd… Both the CEO and the board of directors

expect to be made better off through the arrangement made in placing the new CEO at the helm of a publicly traded organization

Having more resources as a successful business to obtain the best leaders to generate profit for shareholders than the competition is a desired situation

Unfortunately some CEOs place the organization at risk post hiring

Utilitarian maxim provides a logical basis for carrot and stick policy

Justice Theories It is in nature of things that all persons cannot,

and should not be, treated equally When persons are treated unequally, it must

be based on some defensible reason Treating unequals as equals is unjust in itself People should be treated equitably, that is,

equality based on justice The position of an executive is not one that

can be easily filled Higher the position held in the corporate

hierarchy greater the compensation

Right Theories Ethical decisions should protect the legal and moral

rights that an individual is entitled to Legal rights are protected by law –Disclosure of top 5

executive compensation Moral rights have to be protected by the society-

Widening gap between compensation of CEO and worker compensation

Executives are responsible for managing the corporation on behalf of the shareholders

Problem arises when executives work for their own self-interests rather than working on increasing the value of the firm – Principle Agent Problem

Long-term compensation packages try to align the goals of executives with that of the shareholders

Ethics Of Care Theory about what makes actions right or

wrong Individuals are interdependent for achieving

their interests Consumer is the driving force of corporation's

existence Corporation strives to minister to social and

economic goals beyond that of profit maximization

Case Studies

American International Group (AIG) Bonus Fiasco

Trouble at AIG On September 16, 2008 AIG suffered a liquidity

crisis following the downgrade of its credit rating. AIG got a credit facility of $85 billion from the

Federal Reserve in exchange for warrants for a 79.9% equity stake.

After that American International Group (AIG) has been kept afloat by more than $170 billion in federal assistance since September 2008.

Works out to about $1,500 for every household in U.S.

AIG paid out more than $500 million in salaries and bonuses to hundreds of senior employees, even as it was being bailed out by the government.

Greed of the executives The uproar over AIG pay reached a new level amid

revelations that it rewarded employees with $450 million in bonuses for 2008—when its stock fell from $57.14 a share to $1.57 a share.

Worse, $165 million of the payments were in the form of “retention” bonuses to employees of its financial products division, which sold the complex derivatives at the heart of the company’s financial troubles.

Even more ironic, 52 of the employees quit after receiving their “retention” bonuses.

AIG recorded a $99.2 billion loss in 2008, with a record $61.7 billion loss in the fourth quarter alone.

The rot begins at the top Martin J. Sullivan, AIG’s CEO, who collected a severance

package of nearly $50 million when he was ousted at a board meeting on June 15, 2008, when it came under investigation by the SEC.

Joseph Cassano, who resigned in February 2008 as the head of AIG’s financial products division after it lost $11 billion but was allowed to keep $34 million in bonuses and draw $1 million a month in consulting fees from AIG for seven months.

Robert Willumstad, who replaced Sullivan as CEO in July 2008. He served as CEO for less than three months and collected a $22 million severance package that he later agreed to return after being criticized soundly.

The government then installed Edward Liddy as CEO, when it gave the insurer the first $85 billion in federal assistance last September. Liddy, the third CEO in less than a year, agreed to work for only $1. 

Consequences & lessons New York State Attorney General Andrew Cuomo to stop

a payout of $19 million out of the total $47 million Sullivan was to receive

He also froze $600 million in bonuses for top executives.  Outrage over the recent bonuses prompted the U.S.

House of Representatives to pass legislation approving a 90% tax on bonuses paid this year to employees of AIG and other companies that have accepted federal bailout funds.

AIG’s poor pay practices expose the fallacy of “pay for performance.” 

The potential windfalls for executives were so massive they had nothing to lose by taking on huge risks to create the illusion of profits. 

What we think

Recommendations Compensation should Drive Company and

Individual Performance Balance Short-Term and Long-Term Performance

Demands Link incentive compensation to Company results over

the fiscal year, and delivering it partially as long-term awards that are linked to multi-year performance

Retain Key Talent and Protect the Company’s Interests Cancellation provisions to encourage executives not to

leave the Company for a competitor and to protect the Company’s interests

Claw back provision if an individual engages in certain conduct detrimental to the Company

Contd… Eliminate controversial compensation

practices that conflict with the notions of fairness and pay for performance

Demonstrate credible board oversight of executive compensation

Shareholder’s say should be increased in the process.

Foster transparency in compensation practices and appropriate dialogue between boards and shareholders

Conclusion “Executive compensation is the acid test of

corporate governance” – Warren Buffet To pass this acid test a company will have to do a

fine balancing act to satisfy all the stakeholders involved

Balance the need for a competitive compensation program for executives with the performance, governmental and societal considerations.