The Ethics of Executive Pay

Question: Should executive compensation be left entirely up to the market?

Jun 1, 2008  

by Fil Fraser

Since 2002, when General Electric reached a settlement with the United States Securities and Exchange Commission over its alleged failure to fully disclose the retirement package provided to its former chief executive, Jack Welch, the issue of executive compensation has been the subject of increasingly intense discussion and investigation. In addition to a substantial pension, the package included bodyguards, the use of an $11-million luxury apartment and unlimited access to a Boeing 737 aircraft. There have since been scores of stories involving corporate executives who have given new and dramatic meaning to the term “golden parachute.”

Ken Chapman: principal with Cambridge Strategies Inc., a public policy consulting firm | Online Exclusive: Fil’s Interview with Ken — click here Janet Keeping: lawyer and president of the Sheldon Chumir Foundation for Ethics in Leadership Harold Milavsky: chairman of Quantico Capital Corporation, serves on a number of corporate boards, former CEO of Trizec Corporation

Janet Keeping: The question of executive compensation is unquestionably an ethical one. I think there’s a hugely important public dimension to this because, while I’m no expert, there are studies that have been done on the impact of a very wide gap between the rich and the poor. These “ginormous” executive compensation packages just feed right into that gap and make it worse.

Ken Chapman: There are a number of ethical aspects to compensation. [Determining] compensation exclusively [on the basis of] enhancing shareholder value is a problem. The second problem is that the system can be gamed. We’ve seen that in a number of areas where people have gamed the system in terms of stock trades and option plays and misrepresenting revenues and the timing of booking them, for example. The third thing that bothers me is if you’ve got a closely held directorship, if you’ve got a board very friendly to the president or to the senior executives, then they run the risk of not really being an objective measure on things. The fourth thing that really bothers me is the discrepancy between the “haves” and the elites. The distance between the rich and the poor is one thing, but the gap between the executives and middle management to line workers is critical now too.

Harold Milavsky: You have to hire the right consultants to give you advice in dealing with compensation issues. The compensation committee of the board should hire the consultant. The committee makes a recommendation to the board, which then makes the final decision.

Keeping: Leadership is called for on this, and I certainly think that government spokes-people could talk about the dimensions of this problem and try to bring some sense into it. But I don’t see how one can legislate; we’ve got minimum wages but I don’t see how we can legislate maximum wages.

Milavsky: Compensation is being looked at very carefully now, ever since the big messes in the U.S. and in Canada. Many institutions are now seeking advice on compensation issues. One suggestion is that board members shouldn’t have options. Executives’ compensation should be tied to performance. But if shares are part of the package, they reflect the performance of the company.

Chapman: But the ethical question ought to be, “Is this the way to be operating in the first place?” There’s an old culture that clearly has to be changed. I think there are enough examples of corporations that are screwing up dramatically, where CEOs are going to jail for fraud, and those frauds are encouraged by the compensation structures in many cases.

Keeping: I think that public outrage is there and it’s appropriate that the public be outraged. The public can, even if they’re not shareholders, draw attention to these things; for example, there could be boycotts of certain companies. Of course, shareholders are in the very best position to exercise control over this.

Milavsky: I put a lot of blame on the consultants, because, if they are hired by management, they will work with management to get as much money as they can out of the company. Good corporate governance should have the consultants hired by the board’s compensation committee.

Keeping: There are people who have better leadership skills than others. And there are certainly people who are willing to take on a lot more responsibility than others and work very hard. I certainly don’t think that everybody should be paid the same. But I’m deeply concerned about the damaging effect of big differentials. The ethical dimensions go right to the question of the impact of these huge differentials. People at the lower end of the pay scale are demoralized by these preposterous compensation packages. Their work is worth almost nothing in comparison. I think, as well, that such high salaries tend to promote cynicism and greed because they promote the idea that it’s only money that matters.

Milavsky: [Rakesh] Khurana [author of Searching for a Corporate Savior] makes sense; you can’t do it all yourself. But how you lead can make a huge difference. Welch had the skills to make sure he hired the best – and keep them on the team. The CEO takes all of the credit, but he also carries the can. If the thing goes sideways, who do they blame? The CEO. There is a very competitive marketplace for CEOs. One of the boards I’m on was doing a lot of recruiting and wanted to attract the top people. But they were operating out of Regina, and it was hard to get top people to go there. So they moved some of the senior people, including the CEO, to Calgary. They’re now getting the top people.

Chapman: Board members tend to self-perpetuate. When increasing shareholder value is your primary test, you don’t look at accounting for the full cost of the enterprise. If you look at narrow cost, you possibly tend to exaggerate revenues and mislead on liabilities, especially contingent liabilities like environmental impacts and social consequences.

Keeping: I don’t think that people who are running corporations and making millions of dollars per year are actually doing anything tougher than what a lot of people who are running other types of organizations do. Does anybody really think that it is more complicated to run a profit-making company than it is to run a health authority or to run a major university? We’ve got very demanding jobs in the public sector that are being paid nowhere near what we see in the private sector.

Milavsky: How much is enough? Well, a lot of CEOs do very good philanthropic work. A lot of money gets put back into society. Look up Tony Comper, who retired from the Bank of Montreal, as a good example.

Chapman: The gap between the very wealthy and the middle class, never mind the lower class, people who are homeless and in

poverty – that gap is huge now and that’s one of the early indicators of the breakdown of society, and I think we’re facing that reality now.

FINAL WORD

What is clear is that the responsibility rests chiefly with leaders of the corporate world. No democratic government can fix this. The multiple corporate failures leading up to the sub-prime mortgage catastrophe, driven by CEOs seeking increasingly outlandish packages, has taken the enterprise system close to the brink of self-destruction. Unless the system takes dramatic steps to heal itself, the result could make the Great Depression seem like a picnic.

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