How executive pay gets so out of control

By Lucy P. Marcus
April 3, 2012

Boards are tone-deaf in a soundproof room

Why is it that executive pay continues to seem so out of line with what common sense would tell us is justified?

We’ve seen a number of striking examples over the past several months of compensation packages that, when exposed to the light of public scrutiny, evoke a range of negative reactions, making people anywhere from mildly annoyed to genuinely appalled. The packages seem out of line with results, and pay ratios are striking. Recent cases are unbounded by sector or location and include AstraZeneca, Barclays Bank and Shell. So what happens in the boardroom that lets such a package emerge?

In most board structures, a remunerations committee is assigned to set the level of compensation and determine the components of the pay package that senior executives receive, including base pay, bonus, stock and privileges such as use of the company jet. In recent years this committee assignment has gone from fairly light to as time-consuming as the audit committee.

There are several factors at play as the remunerations committee and the board as a whole try to weave together pay packages.

Compensation consultants. Often compensation consultants are used to help determine the packages of senior executives. Although many make a sincere attempt to prepare a comprehensive view, taking into consideration peer groups, market pressure, and many other factors, they may not fully appreciate how such a package will appear to stakeholders. What they advise may seem fair in the vacuum of the boardroom or on paper, but oftentimes it does not reflect other realities and pressures on the company from stakeholders such as investors, employees and the community at large. Also, there is a real danger that consultants can become part of the problem, driving up compensation packages as they create an aura of ensuring that the CEO and senior team feel fairly compensated relative to their peer group – a sort of “keeping up with the Joneses.”

Personal feelings. Directors may have developed personal relationships with the CEO and senior team and feel as if they must give them a certain compensation to “save face.” Or the directors may feel that the work the executives have done and are being asked to do in the future is onerous and must be compensated in a predetermined way – a way the board is accustomed to and feels reluctant to stray from. This can be a slippery slope, or rather a speedy escalator, as each year the desire to reward and inspire means that ever grander packages need to be put in place.

A disconnect from today’s reality. Those of us in the boardroom can often feel we are in a soundproof room. Even though we come armed with a great deal of knowledge and information, it is hard to factor in all the input from outside voices or truly take seriously some of those voices. The conversation around the table about compensation may sound reasonable in the vacuum of that room, where big numbers can be bandied about, but it is vital that directors have a finger on the pulse of the market and consider how the pay package, or severance package for that matter, will be received by the wider world. Board members who have been through this process often express surprise at the response by the public and had little appreciation or understanding of the impact their decision would have on the company’s reputation.

A lack of direct accountability. To date, most board members have done their work in a “black box,” so the decisions they made went fairly unscrutinized. Even if there was any outcry about the package, the issue was usually not linked back to the board. As such, there was little accountability for individual board members; they did not have to deal personally with any backlash that came as a result of unpopular choices.

This is changing rapidly. The perception and accountability of the boardroom, and indeed the personal accountability of individual board members, has been transformed. Increasingly board members have to demonstrate why they have taken certain decisions or voted in a certain way, and remuneration committees are being asked to substantiate their choices.

Boards need to come to grips with compensation structures of their senior executive teams, and stakeholders need to continue to voice their concerns about compensation packages. CEOs and other members of the C-suite deserve fair compensation for running companies, particularly in demanding economic times, when only organizations with the best talent will survive and thrive. On the other hand, these difficult economic times call for judicious decisions about compensation packages that are more clearly linked to performance and demonstrate that board members are not tone-deaf in a soundproof room.

PHOTO: A gambler counts out cash while making a proposition bet on Super Bowl XLV at the Las Vegas Hilton in Las Vegas, Nevada, January 27, 2011. REUTERS/Las Vegas Sun/Steve Marcus

21 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

Uhh, because all these corporate types know each other, belong to the same country clubs, send their kids to the same elite boarding schools?

Posted by borisjimbo | Report as abusive

You could rewrite this article with one word – GREED!

Posted by minipaws | Report as abusive

I’m always amazed at the media angst over this issue. The truth is it really isn’t any of our business. The board could decide to wallpaper the company headquarters with hundred dollar bills if they so desire. Because a public company is responsible to its shareholders, it is the shareholders who hold the power to vote out the offending board members if they see fit. If the media wants to get their knickers in a knot, they should focus on government funded money pits like Fannie, Freddie and the USPS.

Posted by gordo53 | Report as abusive

It’s not clear to me what you are attempting with this article. Are you offering these points as explanation? Or excuses? Or is it mere analysis? What’s interesting is that I note nothing in your points concerning the good of the company or the good of shareholders — let alone the industry or national economy. The points you raise suggest that boardmembers feel that their decisions are only about them … and the executives. They are truly so irresponsible? Or is it merely that the “public ownership” of these companies is illusory, a minority ownership with no real voting power?

Posted by tejh | Report as abusive

Actually there is a wonderfully simply solution that is fair to everyone: tie senior manager pay to some multiple of the lowest salary in the company. No need for compensation consultants. The board can reduce compensation efforts to the minimum. And you also begin to solve the problem of suppressed wages in the US by making senior managers aware that the pay of their staff matters as much or more than their income (because they’ll always make more).

Posted by FredFlintstone | Report as abusive

1) Changes in the tax code done in the last several decades are to blame. Years ago corporate executives were paid largely in cash or participated in plans to buy shares wherein they had to put in some of the money. Performance-based pay was rare and rarely automatic. Then the Dems in 1993 got mad when some CEO got paid over a million and put in that year’s tax bill a provision eliminating the expense deductiblity of any pay over a million–unless it was based on “performance”. Of course if the company has a good year performance pay will “take off” and it’s open ended, particularly stock-option based pay. This is largely why pay took off in the ’90′s: nearly everyone did well back then hence big pay.
Remove that million dollar deductibility limit and let them be paid in cash–and eliminate performance-based pay; let the CEO buy his own company’s stock with his own money; relax the insider trading rules.
2) I’ve seen the same pay problem in small non-profits such as a glee club with perhaps 10k in annual revenue. The Music Director’s pay keeps going up; now if he leaves for a better post the club might be in trouble and might even fold. Which leads to a reason the article’s author left out:
3) Comp committees also fear that an acceptable CEO might leave them for someone else; this is an unspoken fear and it does happen. A company called TRW: after the retirement of their longtime legendary chief they hired a new head–who then abruptly quit with no notice for another company. TRW stock plunged 40% in ONE DAY; TRW got put into play: Northrup Grumman grabbed it and spun off the automotive end in a new TRW. I don’t know how it’s doing: lots of people probably got laid off.
Would there be a Chrysler today if Lee Iacocca had turned them down in 1981?
There are great parallels between athletes’ pay and CEOs’ pay or the pay for professional singers. The results of being outbid can be fatal for the organization’s existence.
5) Note that the dimwits protesting CEO pay never complain about exhorbitant union pay. Airline union baggage handlers getting $26 an hour to steal luggage. Not one peep about 100,000 GM guys being paid to do nothing. Oh, they got laid off in the last contract but I wouldn’t be surprised to see Obama Motors hire them back to do nothing.

Posted by Redshield | Report as abusive

1) I’m a Dem. But I get it. CEOs deserve (and get) the pay they earn. Maybe the problem is bigger than one paycheck?

And 3) because I can’t resist: Redshield, your contribution is both valuable and well thought out. but you left out 4). *shrug*

Posted by io999 | Report as abusive

Duh,ever taken an economics class? Didn’t think so. Wages are determined by supply and demand. End of story. Most community colleges could help you with this.

Posted by DanPM | Report as abusive

I’m glad you see reform on the way. I do not. As long as board members are in one way or another hand picked by the CEO, board members will continue to rubber stamp whatever the CEO proposes.

Posted by possibilianP | Report as abusive

To the person who says it isn’t any of our business, I have about 1.5 million dollars of ownership in various corporations, and IT IS MY BUSINESS!

Posted by possibilianP | Report as abusive

For the next big economic crash, these people should be TOAST

Posted by KyuuAL | Report as abusive

Self government without self control will never work. Corporate America has no problem placing controls on the workers as does the federal government. The congress can pass laws on healthcare that they themselves don’t have participate. If CEO’s and top executives don’t start exercising some self control or sharing the wealth then the government will do it for them. It only takes a totalitarian like Obama and his radical supporters. He’s already pitting the rich against poor, blacks against whites, democrats against republicans, religious against secular. CEO pay is a reflection of our government and our government is a reflection of us. Both or the same need to start exercising some self control. Batista couldn’t back in the 50′s and Cuba got Castro. The alternative isn’t always better.

Posted by JavaJoe | Report as abusive

A multitude of working people making minimum wage, no benefits, can be fired at will…often one paycheck away from homelessness…Here at home in the US. These greedy sociopaths (kinder than the words I might use) steal millions. They make a mockery out of the words “freedom” and “prosperity” as used in our constitution. Shame, shame, shame.

Posted by keroline | Report as abusive

Whether these bad bad bad cases of greed take place in government or in the coporations–it is the business of all of us. We need to become a country where there are not such extreme disparities. EVERY working person should be able to have a decent life.

Posted by keroline | Report as abusive

I disagree with gordo53. Shareholders are the victims here. They own the company not the CEO. However, the CEO appoints the board, and the shareholders have no alternate candidates. Board elections are exactly like elections in the old Soviet Union – one slate of candidates who always win. CEO pay is way out of control.

Posted by QuietThinker | Report as abusive

I do not understand why it is considered okay for the CEO et al to receive performance-related pay when a company is not improving and at the same time redundancies occur. Surely, the humblest worker and the most senior member of staff all work to improve profits. Therefore, they should all be on a related pay-scale. My suggestion would be 1:100 – the boss gets 100 times the pay of the lowest employee.

Posted by GinaSwifte | Report as abusive

Tying CEO pay to a multiple of the lowest salary would still be the most direct, fair, and predictable solution.

To @Redshield’s point about TRW, the problem is less the mobility of senior executives and more the high pay at other companies acting as a lure and a failure of TRW, in this case, to properly plan succession management.

The unpredictable nature of CEO pay allows companies to do what states do using low taxes to lure companies to set up in their states: the short term benefit of jobs is offset by less revenue for critical infrastructure and services in that state. Allowing CEO pay to be as loosely defined as it creates a similar negative dynamic. Negative to investors, customers (who pay higher prices), and workers.

There are least four stakeholders in any large public company: investors, managers, workers, and customers. The current pay system gives outsized benefits to the managers at the expense of the other three stakeholders.

Posted by FredFlintstone | Report as abusive

If you don’t like the way the company is run, you can sell your stock. In a fortune 500 company, executive pay amounts to a rounding error on the company books. This just more mindless deriding of the rich. Grow up.

Posted by gordo53 | Report as abusive

Wow! Did anyone learn anything new from this article? Wish I could be paid for writing a few obvious notes about exec comp.

Posted by yogahelps2 | Report as abusive

Throw the stockholders under the bus. Most of them are just mooching off of whatever dividends they get, worsening speculation. Board members ARE hand picked by the CEO.
The CEO isn’t usually mature enough to handle the bad news so he only picks the board members who are going to serve his preferences. GREED is just the appetizer. GLUTTONY is the main course and LAYOFFS are for dessert.

Posted by laguardia23 | Report as abusive

I think we should revert to the wild west. In the old days, workers were ignorant of such things, but with the knowledge we have now about business, outcomes would be much different. Once we found out how much money was being made by our hard work, and how much the executives were being paid compared to us workers, we would all say “get a rope”. The people who work for the profit of the company should be paid dividends far greater than those who simply have the luxury of investing. Face the facts people, the rich have been screwing the poor since the beginning of time. Why? Greed, and because they can. Ask yourself who works harder for their money? The investor or the man risking his life, his family’s well being, his children’s education, and his family’s health, breaking his back drilling oil;working in the mine…etc.? Who deserves the most dividends for their efforts and risk? Who truly is risking the most?

Posted by Blackbird1996 | Report as abusive