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How to Think about the Ethics of Executive Compensation

Oct 16

Written by:
10/16/2014 9:24 AM  RssIcon

By Dan Sweeney
Director, Institute for Enterprise Ethics

Introduction

Federal ReserveOn May 8, 2014, the Institute for Enterprise Ethics hosted a Governance and Leadership roundtable discussion entitled “How to Think About the Ethics of Executive Compensation”. The discussion was moderated by John Balkcom, independent director and former executive compensation consultant and Lisa Victoravich, associate professor in the School of Accountancy at the Daniels College of Business. During the discussion, a participant raised the issue of wealth disparity and how it related to executive compensation. Given the importance of the subject matter and the strong interest displayed by the participants regarding that specific issue, the Institute decided to host a more focused roundtable discussion follow-up discussion on the topic of Executive Compensation and Wealth Disparity.

The Philosophical Framework

The follow-up discussion, held on October 2, 2014 was moderated by Buie Seawell, clinical professor in the Department of Business Ethics and Legal Studies at the Daniels College of Business. The participants included eight senior level executives and four Daniels faculty members.

Professor Seawell began by posing a fundamental question paraphrased from Aristotle: What is the end of executive compensation and what is the purpose of the compensation paid?  Seawell discussed the opposing philosophical views of John Rawls and Robert Nozick posing the question: “Is it simply an issue of what is legal and what is not?  Or is it a question of what is Just?”  And, do patterns such as the ratio of high to low pay in US Corporations, the disparities in the distribution of wealth and incomes in the US and the disproportionate unemployment rates among various social strata really matter? Rawls would say yes and we should act; Nozick would say no and we should let the market take care of things.

Questions

Professor Seawell’s philosophical question prompted a number of other practical questions from the group:

  • For what matters outside the boundaries of a corporation do a company, its board and its executive team, have some level of responsibility?
  • How should a company’s policies such as executive compensation address that responsibility?
  • Do current executive pay practices aggravate the wealth gap? And, if so, what should a company do about it?
  • Whose responsibility is it to be sure that our economy is providing employment and producing value?

Issues

The discussion then moved on to a number of reasons why executive compensation has grown so fast and is so high, including:

  • When the tax code was changed to limit compensation to $1million unless it is related to performance, that limit almost immediately became the salary floor for CEO’s.
  • Compensation is not just an economic transaction, but also a psychological reward feeding the desire for status
  • Compensation is also seen sometimes as a tournament, reflecting how executives compete with each other not only for compensation packages, but in the marketplace as well.
  • Supply and demand, that is because the supply of executive level talent is so small they can command such a high rate of pay. This prompted much debate around the table.
  • Executives take on positions with high tradeoffs and risk. Does that justify their higher compensations?
  • Why is executive pay in the US so much higher than in the rest of the western world?

Other issues covered topics with a wider range social and economic implications, including: 

  • Does the corporation have a responsibility to consider the distribution of wealth among those who contribute when making compensation policy?
  • Do corporations distribute wealth more effectively than the government? Is the lack of trust in the government a major factor?
  • What does more money contribute to the capacity of an executive to effectively lead a company?
  • What impact does shareholder value have on executive compensation?
  • Does too much of the marginal wealth from “excess” compensation get reinvested in the artificial financial economy instead of in the real, productive economy where employment produces spendable income?
  • Unless reined in, societal pressure will eventually impact the compensation policies and levels. What will be the tipping point? How can we effect that change?

Conclusions

In general, the participants agreed that the compensation practices of major corporations and financial entities such as hedge funds contribute significantly to the widening income and wealth gaps in the United States. There was also general agreement that this wealth and income disparity presented a potentially very significant problem for our society. Much less consensus was found in the question of what, if anything, corporations should, or even could do about this problem. It was suggested, however, that boards of directors should look at this issue and take it into consideration when determining compensation policies.

When queried about what the Institute for enterprise Ethics might do to advance this discussion, the most common response was to continue the discussion with a broader range of participants.

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