The average CEO of a large company earned $18.3 million in the United States in 2021, which is about 324 times the average worker’s pay. CEOs also tend to receive larger raises than their workers.
CEOs at companies on the S&P 500 list received average raises of more than 18 percent in 2021. But, most workers received raises of only about 5 percent.
Executive compensation has long been a subject of debate in the United States. Some say that lucrative compensation packages are necessary to attract and retain top talent. Top talent is critical to delivering value to shareholders and keeping the company profitable.
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Profitability is necessary for companies to continue employing workers. Others say the income disparity between top executives and average workers is excessive.
The disparity negatively affects the overall economy because it slows growth. Some groups also say executive compensation structures encourage unethical behavior by tempting CEOs in their self-interest rather than the company’s.
As executive compensation continues its upward trend, consumer polls say that most Americans favor executive pay limits. Yet, despite negative opinions, CEO pay continues to rise significantly.
Here’s a look at executive compensation, how boards determine it and when it becomes unethical.
What is Executive Compensation?
Executive compensation involves more than wages. It refers to all the cash, incentives, benefits, and perks a company grants its executives.
The components of an executive’s compensation package will differ depending on several factors. A major factor is whether the company is publicly traded on the stock exchange or private.
The salary is a fixed base salary, expressed annually. On average, salaries are about 30 percent of executives’ compensation packages.
Many CEOs in today’s market receive signing bonuses to accept an offer. The rewards are designed to recruit a talented CEO who may have many offers.
Signing bonuses are more extensive if the CEO will join the company in mid-year. CEOs who leave their current companies in midyear often lose bonuses.
Short-term and long-term incentives
A typical executive compensation structure will include short- and long-term performance incentives. Many executives receive cash bonuses if they and the company achieve specific goals or meet key performance indicators in the short term. These annual bonuses typically constitute about 20 percent of the compensation package for executives in public companies.
Many corporations, especially public companies, also offer equity compensation. Equity compensation aligns the executive’s long-term interests with the company’s corporate performance. The better the company performs, the more the value of the executive’s stock will grow.
Equity compensation also usually has a vesting rule, which can improve retention. Vesting means that the executive doesn’t own the shares of stock until they’ve been with the company for a specific time or reached a particular milestone. Because equity helps the executive build their wealth, they often stay with the company until vested.
Equity-based incentives include stock options, restricted stock units, and performance stock. Stock options allow the executive to buy shares at an agreed-upon price once the executive vests.
Restricted stock units are corporate promises to grant the executive certain shares of stock when they vest. Performance shares vest at share prices based on the company achieving specific financial metrics.
Long-term equity-based incentives typically comprise about 40 percent of executive compensation in public companies.
The value of perks or perquisites has increased since the pandemic. Typical senior management perks can vary. They often include free use of the corporate jet, a company car and driver, security, amd country club and airline club memberships.
They may also include company-paid electronic devices. Some executives also receive free annual physicals, tax preparation, and entertainment tickets. Many also receive relocation assistance.
This help often covers all moving expenses. It may also help them sell their houses or buy homes in the new location and allow free use of temporary apartments while house hunting. Some companies will pay private school tuition for executives’ children, mainly if they are in cities with few good public education options.
Benefits include health insurance, 401ks and other retirement plans, time off, and disability insurance. Some executive packages also cover 100 percent of out-of-pocket medical costs.
A guaranteed severance package
Most executives work at the will of the board of directors, which can dismiss them at any time, whether for good cause or not. Because of the at-will nature of their employment, many will negotiate a severance package as part of their initial employment contract. However, an executive and the company sometimes add severance packages later once the executive has proven themselves.
Severance packages can include a cash lump sum or the executive’s salary over several months or even a year. Often, the executive may receive several times their base salary. They also may receive partial payments of their annual bonus.
The package also typically provides for the continuation of health insurance benefits. It also may include provisions that the executive avoid opening a competing business or sharing trade secrets with a competitor. It also may have a clause that neither the company nor the executive say anything to injure the reputation of the other.
In the past, some senior executives received severance packages (disparagingly called “Golden Parachutes” worth hundreds of millions of dollars. General Electric CEO Jack Welch received $400 million in 2001.
Severance packages have gotten smaller recently, but many still are in the 10s of millions. For example, Jim Murren of MGM Resorts International recently received $32 million. The late Ronald Rittenmeyer, former Tenet CEO, received more than $11 million in stocks and bonus payments.
Key Factors Determining Executive Compensation
The board of directors determines executive compensation based on several factors, generally based on recommendations from a compensation committee. The first is whether the company is private or public. Executives at public corporations tend to receive the highest compensation.
Another factor is the overall complexity of the job. If the executive works in a dynamic environment where they must be flexible or make significant changes, they may receive more money.
A third factor depends on the industry. Compensation committees often study companies in their industry peer groups when setting compensation.
They also may hire a compensation consultant for industry advice. Of course, the CEO’s compensation package already at their current job will affect what the new job offers. And finally, the company’s financial situation and ability to pay will be a factor.
Pros and Cons of High Executive Pay
Advantages of High CEO Pay
Market forces often are a significant factor in CEO compensation. CEOs are highly skilled people who must understand and practice smart risk-taking.
They also must be visionary and be able to lead others toward a vision. Often, the demand for talented CEOs exceeds the supply.
A lucrative executive compensation package may be necessary to lure a capable CEO. A talented and effective CEO who boosts financial performance may be a better value than a less-talented one who fails to meet growth goals.
High executive compensation also can have other advantages for corporations, the economy, and society if structured appropriately. If a more significant part of CEO compensation links with company performance and revenue, the CEO will have a great incentive to manage the company well.
A well-performing company can contribute to a strong economy by hiring employees. If the company donates part of its profits to charity, society also benefits from the solid firm performance.
Disadvantages of High CEO Pay
Lucrative executive pay also has some disadvantages for corporations, the economy, and society. A large pay gap between senior executives and employees can lead to poor morale. Employees who work hard for relatively small salaries can become resentful, and their resentment can lead to a toxic work environment.
High executive pay can also widen the gap between rich and poor, negatively affecting social mobility and contentment. The pay gap may also slow economic growth.
Federal regulations require public corporations to disclose the compensation packages of their highest-paid executives. The public often perceives high CEO pay negatively, especially in times of economic downturn.
Corporations that compensate executives lavishly may have public relations issues that can affect their brand. These issues worsen if the company is also known for paying lower-level workers poorly or failing to meet shareholders’ expectations.
Even if CEO compensation is reasonable, it can still pose problems for a company if the package is not structured thoughtfully. For example, a package weighted too heavily toward bonuses might encourage the CEO to focus too much on achieving short-term goals at the expense of long-term strategies that can sustain the company.
Executive compensation packages excessively weighted toward stock options can also result in excessive risk taking because stock price rises increase the executive’s wealth. They also can encourage unethical reporting practices that manipulate short-term data.
Companies with Controversial CEO Pay
Companies that overpay their CEOs often become embroiled in controversy. Firms that give significant raises to CEOs and board members while simultaneously cutting compensation for other employees or eliminating jobs also receive criticism.
Aptiv, a large automotive parts company, lists a compensation increase of $31 million for its CEO in 2021. The compensation increase exceeded the CEO’s salary the year before.
However, Aptiv cut the pay of its average worker by 19 percent. Aptiv says the figure included an accounting adjustment that wasn’t additional compensation. It said its CEO, Kevin Clark, actually made only $13.5 million.
However, according to CBS, Clark’s pay was still 2,279 times the median pay of Aptiv’s employees, even using the lower figure. Aptiv says the wide gap occurs because many of its employees are in lower-wage countries outside the United States.
Warner Bros. Discover
David Zaslov, CEO of Warner Bros. Discover, is the most overpaid CEO in America, according to a shareholders advocacy group quoted in Time magazine. Zaslov received $246 million in 2022 even though the company’s stock fell 60 percent that year.
More than $200 million of that came from stock options Zaslov received in anticipation of the merger of Discover with Warner Bros. The magazine says about 40 percent of shares voted against the pay package.
Google employees resent CEO Sundar Pichai’s pay in 2022, which reached $226 million, including stock awards. Google announced in early 2023 that it was eliminating 12,000 jobs to cut expenses.
Amazon’s new CEO, Andy Jassy, earned $212.7 million in compensation in 2021. However, the average Amazon worker earned only about $32,000. Amazon told CNN Business the pay gap resulted from financial reporting rules that required them to list stock options and grants as 2021 income, even though Jassy would not be vested for several years.
Differentiating Between Ethical and Unethical Executive Compensation Practices
Executive compensation becomes unethical when companies fail to address wide income disparities. It is also unethical when managers and board directors increase executive compensation when workers lose their jobs. Firms have an ethical duty to provide all their workers with a living wage. Compensation is also unethical if its structure tempts executives to make decisions that damage the company in the long run.
Compensation practices may also be unethical if
- independent directors favor expensive compensation packages because they have become friendly with the CEO
- or independent directors vote in ways that protect their position rather than based on what’s best for the company or its shareholders.
Real World Examples of Ethical Executive Compensation Packages
Some companies have succeeded in offering ethical compensation packages.
Kimko Realty is America’s largest publicly traded real estate investment trust (REIT). It is an example of a firm with an ethical CEO compensation package. CEO Conor Flynn earns 11.63 million.
His base salary accounts for only about 8 percent of his package. Bonuses comprise the rest of his compensation.
His compensation dropped in 2018 and 2019 when corporate earnings dropped. It failed to decrease when earnings dropped during the COVID pandemic, however.
Kimko’s compensation package is ethical because the pay gap between Flynn and the workers is among the lowest in the United States. The average worker earns about $111,000, which makes the pay gap ratio about 105:1.
CMS Energy is a holding company for Consumers Energy, a utility in Michigan. The compensation package includes a base salary, annual bonus, and restricted stock. The CEO’s compensation is comprised of about 15 percent from base salary and 22 percent from the annual bonus, with the rest being from restricted stock.
CEO Patricia A. Pop earned about $8 million. The average worker earned about $109,000, making the ratio 74:1.
The average worker also received an annual bonus, although it represented a smaller portion of their overall compensation. CMS employees also received perks often reserved only for executives, such as a free physical and some relocation monies.
See Related: List of Top Renewable Energy Private Equity Firms
Suggestions for Ethical CEO Compensation Policies
Changing Corporate Structures
Executive compensation can still be lucrative enough to attract top talent while also being ethical. Changing corporate governance structures to allow shareholders to restrain executive pay better may lead to more transparent and,more ethical compensation practices. Being on a corporate board of directors is lucrative, often paying $100,000 annually.
Once shareholders elect a board member, the board member often tends to stray from protecting shareholder interests. Instead, they try to fit in with other directors and executive greed and keep their positions.
They also build a relationship with the CEO. They may be reluctant to suggest reductions in CEO compensation.
Increasing Employee Access to Stock
Companies can further decrease compensation gaps by increasing employee access to stock and putting employee representatives on boards of directors. Another way to make compensation more equitable is to provide incentives to all levels of employees.
The incentives would be tied to achieving overall corporate strategies. For example, suppose the strategy is to promote profitable growth. Employees and senior executives would receive incentives for annual sales, gross margin, and long-term stock appreciation increases.
Federal Government Intervention
Federal government intervention also can make CEO compensation policies more ethical. For example, taxing companies with a significant pay gap between CEO and worker could encourage compensation committees to address the gap.
The government also could impose rules requiring CEOs to hold stocks they receive as pay for several years. Such a rule may limit CEOs from benefiting from short-term strategies that hurt the company in the long run.