Management's primary goal is to maximize stockholder wealth



Executive Compensation

Management's primary goal is to maximize stockholder wealth. Firms often award stock options and bonuses on the basis of management performance, thus linking management's personal wealth with the firm's financial performance. The better the job managers do in maximizing share price, the greater their compensation.

However, many people (including labor groups) argue that executive compensation has gotten out of control. They cite CEO compensation relative to employee compensation and suggest that CEOs are receiving far too much pay. There is no perfect way to determine how “fair” an executive’s pay is, but we can compare firm’s stock prices and see if the executives with the most pay are leading their companies to above average returns. In fact, we often find that the highest paid CEOs are often from firms that are not household names.

A leading US labor union, the AFL-CIO, has set up a section of its website to address executive compensation. Because the AFL-CIO tries to act in the best interest of workers, they have an incentive to keep a watch on CEO pay and alert workers about it. Use this site and Yahoo!Finance to answer the following questions.

a. Access the AFL-CIO’s Executive PayWatch website (found at ). Looking at the list of the past year’s most highly paid CEOs, which companies (and CEOs) do you recognize?

Obviously, answers here will vary depending on the composition of the list and the student’s individual knowledge of different companies. On the 2006 list, Apple Computer, Home Depot, UnitedHealth Group, KB Home, Caremark Rx, and Pfizer are probably the most famous names.

b. According to the article about Trends in CEO Pay, how does executive pay in the most recent year compare to the previous year, and to nonsupervisory workers?

The 2007 survey reports that average CEO pay was $15.06 million in 2006, which represents an 11.5% increase over 2005’s average.

c. Have any trends emerged relating CEO pay and average worker pay?

According to a chart in the article, the ratio of CEO pay to average workers was about 42 in 1980, 107 in 1990, 525 in 2000 and 364 in 2006. This indicates that the ratio has fallen from the previous astronomical heights, but is still very high relative to past decades.

d. According to the article, what is wrong with CEOs taking such a large share of wealth?

Excessive CEO pay takes money out of shareholders’ pockets and poorly designed executive compensation packages can reward decisions that are not in the long-term best interest of the company, the shareholders, and employees.

e. How has the composition of executive pay changed recently? Have these changes been for the best?

According to the article, while CEO pay has continued to grow, companies have begun moving away from over-relying on stock options and are adopting more sensible forms of executive compensation. The NY Times reports that stock options make up just 31% of the average CEO’s pay, compared to 69% in 2001 (a steady decrease). Stock options can provide incentives that are not in the long-term best interest of shareholders. Stock option grants provide executives with the potential to benefit from all the upside without bearing any risk for the downside. However, In 2006, the U.S. Securities and Exchange Commission (SEC) unveiled new rules for disclosing executive compensation. These new rules go further than ever before in revealing just how much executives are paid, making transparent previously hard-to-find information such as pension and estimated severance package totals.

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