CEO Pay in the Context of Society

An alternative approach is offered by Jay Lorsch and Rakesh Khurana in The Pay Problem, Harvard Magazine, May-June/2010, which theorizes find that the current compensation trouble stems from unexamined assumptions about the purpose of boards, executives, and the corporation.

The underlying assumption that executives would work more effectively if their monetary rewards were tied to results built on incentives for factory workers, using piece-rate schemes advocated by Frederick Taylor. But these prescriptions missed two complications when applied to senior executives:

• often executives have little or no control over the results they rewarded for achieving; and
• results are more often produced by a group of executives or even by an entire organization’s effort.

Turnover in chief executive suites led to a belief of a well-functioning market for senior executive but compensation in reality depends much more on negotiations than anything like a market rate. Another factor that transformed compensation was agency theory that linked top executives’ pay plans to a firm’s stock price. “Prominent business organizations switched from advocating a ‘stakeholder view’ in corporate decisionmaking to embracing the ‘shareholder’ maximization imperative.”

In 1990, for instance, the Business Roundtable, a group of CEOs of the largest U.S. companies, still emphasized in its mission statement that “the directors’ responsibility is to carefully weigh the interests of all stakeholders as part of their responsibility to the corporation or to the long-term interests of its shareholders.” By 1997, the same organization argued that “the paramount duty of management and of boards of directors is to the corporation’s stockholders; the interests of other stakeholders are relevant as a derivative of the duty to the stockholders.”

“Executive pay is rising not so much as a driver of improved performance, but as a consequence of improving performance and an accompanying rise in equity values.”

The authors want to move from the prevailing paradigm, which regards managers as needing to be bribed to perform, back to something like when managers were viewed as professionals with obligations to various “stakeholders” and to the broader society.

Re-thinking the nature of executive pay within the context of our larger economic and social system and the challenges we face may enable us to create a new model of compensation rooted in a more realistic recognition of the social context within which firms operate. It should, and can, rest on valid assumptions and fundamental values that allow us to build a more inclusive and sustainable economic future—one in which we don’t have to bribe executives to do the duties we have entrusted to them.