CASE STUDY: The Debate over CEO Compensation
The most visible and highly paid person in most corporations is the chief executive officer (CEO). CEO compensation is particularly important to firms for three reasons. First, the compensation package is likely to be important in attracting and retaining good CEOs. Second, the form of the pay contract is likely to help determine whether the CEO focuses on value maximization or some other objective. Third, employees throughout the organization carefully follow their CEO’s pay. Important morale problems can occur when employees think that the CEO is overpaid. For instance, employees complain bitterly when they are asked to take pay cuts because the company is in trouble, yet at the same time the CEO gets a big ...view middle of the document...
disclosed it had paid out a $77 million compensation package for CEO Christos M. Cotsakos in 2001- a year in which the financial-services company lost $242 million. When Cotsakos pledged later to return $21 million, the complaints hardly subsided. In 2001 Qwest Communications posted a $4 billion loss and employees were laid off. However, Qwest’s CEO, Joseph Nacchio, received a $1.5 million bonus, $24 millions in cash, $74 million in exercised options, and was granted 7.25 million in new options. In 1980, CEO compensation was 42 times that of the average worker. In 2000, it was 531 times.
The second major criticism of CEO pay concerns how CEOs are paid. Critics argue that CEOs are agents of stockholders and that CEO pay should be based heavily on stock-price performance. In some celebrated cases CEO pay appears disconnected to CEO performance. For example, Ford Motor Co. reported $5.45 billion loss in 2001. Workers were laid off, and salaries for nearly everyone left suffered. Even though former Ford CEO Jacques Nasser was fired, he still received about $20 million in compensation for the year. Since 1980, the increasing use of stock options has boosted the sensitivity of the average CEO’s wealth to firm performance. However, the absolute sensitivity of CEO wealth to performance remains small. Research indicates that for a $1,000 change in firm value, the wealth of the average CEO of a large public corporation changes by only about $10.57. Some argue this relation (which is equivalent to the CEO owning 1.057 percent of the common stock) is too small and that most companies would be better off if they increased incentive pay for CEOs. Some support for this view seems to come from studies that document an increase in stock price when companies announce that they are increasing incentive pay for CEOs.