Corporate Governance Reform and CEO Compensation: Intended and Unintended Consequences

Recent scandals allegedly linked to CEO compensation have brought executive compensation and perquisites to the forefront of debate about constraining executive compensation and reforming the associated corporate governance structure. We briefly describe the structure of executive compensation, and the agency theory framework that has commonly been used to conceptualize executives acting on behalf of shareholders. We detail some criticisms of executive compensation and associated ethical issues, and then discuss what previous research suggests are likely intended and unintended consequences of some widely proposed executive compensation reforms. We explicitly discuss the following recommendations for reform: require greater independence of compensation committees, require executives to hold equity in the corporation, require greater disclosure of executive compensation, increase institutional investor involvement in corporate governance (including executive compensation), and require firms to expense stock options on their income statements. We provide a brief summary discussion of ethical issues related to executive compensation, and describe possible future research.     

Does ‘Best Practice’ in Setting Executive Pay in the UK Encourage ‘Good’ Behaviour?

We examine how UK listed companies set executive pay, reviewing the implications of following best practice in corporate governance and examining how this can conflict with what shareholders and other stakeholders might perceive as good behaviour. We do this by considering current governance regulation in the light of interviews with protagonists in the debate, setting out the dilemmas faced by remuneration-setters, and showing how the processes they follow can lead to ethical conflicts.Current ‘best’ practice governing executive pay includes the use of market benchmarks to determine salary and bonus levels, significant levels of performance-related pay, the desire for executives to hold equity in their companies, the disclosure of total shareholder return compared to an index, and a perceived need for conformity, in order to grant legitimacy to policies. Whilst each of these may in some circumstances lead to good practice, each has the potential to cause dysfunctional behaviour in executives. Overall, we conclude that although best practice might drive good executive behaviour that coincides with the company’s and key stakeholders’ objectives, there are many reasons why it should not.     

Justice in compensation: a defense

Business ethicists have written much about ethical issues in employment. Except for a handful of articles on the very high pay of chief executive officers and the very low pay of workers in overseas sweatshops, however, little has been written about the ethics of compensation. This is prima facie strange. Workers care about their pay, and they think about it in normative terms. This article's purpose is to consider whether business ethicists' neglect of the normative aspects of compensation is justified. I examine several possible justifications for neglecting compensation and show that they fail. What remains is a case for thinking that it is worthy of normative analysis.     

The Effects of Fraud and Lawsuit Revelation on U.S. Executive Turnover and Compensation

This study investigates the impact of fraud/lawsuit revelation on U.S. top executive turnover and compensation. It also examines potential explanatory variables affecting the executive turnover and compensation among U.S. fraud/lawsuit firms. Four important findings are documented. First, there was significantly higher executive turnover among U.S. firms with fraud/lawsuit revelation in the Wall Street Journal than matched firms without such revelation. Second, although on average, U.S. top executives received an increase in cash compensation after fraud/lawsuit revelation, this increase is smaller than that of matched non-fraud/lawsuit firms. Third, fraud/lawsuit firms were more likely to change top executive when chief executive officer (CEO) was not the board chairman and CEO had been on the board for a short time. Fourth, fraud/lawsuit firms were more likely to reduce their executive cash compensation when profitability was low, firms were involved in fraud, the compensation committee size was small, and the board met more often. These findings indicate that although, in general, U.S. fraud/lawsuits firms did not reduce their executive cash compensation, those involved in fraud were more likely to reduce their executive cash compensation than to change their top executives. The finding, that ethical standards is not a significant factor for U.S. executive turnover nor compensation reduction, suggests that ethics appears to play no part in the board’s decisions, and that U.S. firms may have ethical standards in writing but they do not implement nor enforce the standards.     

Ethical choices in the design and administration of executive compensation programs

Within the past few years, executives have come under increased scrutiny and criticism for the levels of compensation they receive. At the same time, corporate practices surrounding the design and review of executive compensation programs have received increased attention. While some recent executive misconduct has involved violations of the law, many academics and other corporate critics view the issues involving executive compensation more from an ethical than a legal perspective. Several dimensions of the executive compensation decision process offer significant opportunities for ethical choices. This article identifies the major components of executive compensation and highlights decision points in the design and administration of each component where ethical issues may arise. Proposals to reduce the potential for ethical misconduct are also offered.     

How Ethical are U.S. Business Executives? A Study of Perceptions

Not much has been written about how the ethics of U.S. business executives are perceived by the American public, yet the perception of integrity is important to both businesses and their investors. This study examines the U.S. public’s perceptions of the ethics of American business executives using Gallup Poll data for the past thirty years. Organizations with unethical executives have trouble attracting investors, customers, and new managerial talent. They suffer lawsuits, market share deterioration, and often prison time for the once-revered leaders. This study also looked at the U.S.’s relative standing on the Corruption Perceptions Index and the Edelman Trust Barometer. Confidence in the ethics of the U.S. business executive remains fairly low on the Gallup Poll surveys and the U.S. has declined on the CPI and Edelman Trust Barometer.     

Underpaid and Corrupt Executives in China’s State Sector

This study examines the role of executive compensation in public governance. We collect data on corruption cases that involve top-level executives in Chinese listed state-controlled firms. We find a significant positive relationship between underpayment of executives and the likelihood of an investigation into corrupt behavior. We also show that corruption is positively associated with firm performance and that the relationship between underpayment of executives and corruption is influenced by firm performance, suggesting that top managers are more likely to engage in illicit behavior if they are compensated poorly while the firms under their control perform well. Finally, we find that pay-performance sensitivity decreases when top executives are involved in corruption investigations, indicating a lack of pecuniary incentives. Our empirical findings point toward an important relationship between executive compensation and corrupt behavior, thus providing valuable input to the understanding of executive pay and its effects in China’s state sector.     

Customer satisfaction underappreciation: The relation of customer satisfaction to CEO compensation

Customer satisfaction contributes to firm financial performance, but does it contribute to top executives' pay? Our empirical evidence shows that it may not. Customer-satisfying executives tend to have lower pay than their productive peers, even if both satisfaction and productivity contribute to firm financial performance. Thus, customer satisfaction is underappreciated, which may result in both less societal welfare and worse company performance. We propose a board myopia mechanism to account for this phenomenon. In facing short-term financial performance pressure from investors, and the asymmetric information availability between accounting-based and market-based assets for compensation decisions, the board of directors may be myopic, underappreciating executives who invest in market-based assets such as customer satisfaction that drive long-term returns. We examine this satisfaction underappreciation phenomenon empirically using 23 years of panel data that detail firm productivity, customer satisfaction, firm financial performance, and executive compensation. The longitudinal data are analyzed using fixed-effect panel models and a simultaneous system of panel vector autoregression equations with interactions to assess the direct effect of firm financial performance and its carryover effect to executive compensation across executives who are productive, customer-satisfying, or both. The results confirm that customer-satisfying executives are underappreciated: being productive is financially rewarding for both firms and executives, while being customer-satisfying is financially rewarding for firms but not as much for executives. We further demonstrate that using total shareholder returns to benchmark firm financial performance and reward executives with a higher proportion of stock compensation can encourage a long-term focus that alleviates this customer underappreciation.     

The economic psychology of incentives: An international study of top managers

The world-wide inflation in executive compensation in recent years has been accompanied by an increase in the prevalence of long-term incentives. This article demonstrates how the subjectively perceived value of long-term incentives is affected by risk aversion, uncertainty aversion, and time preferences. Based on a unique empirical study which involved collecting primary data on executive preferences from around the world, and using a theoretical framework which draws on behavioral agency theory, we conclude that, while long-term incentives are perceived by executives to be effective, they are not in fact an efficient form of reward, and that this outcome is not significantly affected by cross-cultural differences. We conjecture that boards of directors, acting on behalf of shareholders, increase the size of long-term incentive awards in order to compensate executives for the perceived loss of value when compared with less risky, more certain and more immediate forms of reward.     

The influence of firm and executive characteristics on performance-vested stock option grants

Motivated by the considerable changes over the last two decades in the form and composition of executive remuneration schemes and the increasing use of performance-vested stock options (PVSOs), this study examines the determinants of PVSO grants. Using data on 4193 executive-year observations of 1373 executive directors in 243 FTSE 350 non-financial companies from 1999 to 2004, I examine the factors that influence PVSO grants at both the firm and the executive level. While controlling for unobservable industry, firm, and executive level fixed effects, the evidence shows that the PVSO grants awarded to individual executives are associated with observable features of corporate governance and indicators of managerial power. More specifically, the results support the following statements: (1) good corporate governance structures facilitate the use of PVSO plans; (2) the proportion of PVSO grants in the total compensation package is smaller for top mangers with more controlling power; (3) PVSO plans are less frequently used to compensate managers who are approaching their retirement and/or have a large equity stake in the firm; (4) relative to non-CEO executives, CEOs are more likely to be rewarded with PVSOs.     

An Experimental Study of Executive Decision-Making With Implications for Decision Support

Past research in the field of information systems has explored factors and conditions that are relevant to decision-making in many contexts. However, very little is known about how executives consider, weigh, and integrate these factors. One current school of thought holds that intuition and instincts can play a significant role and that when decision-makers use their instincts, they rely on only a relatively small subset of the cues available to them. This has implications for designing and improving decision support systems, which form a major and widespread element of modern organizational computing. We examine the decision-making policies of professional decision-makers. High-level information technology executives were asked to evaluate the likelihood of making a strategic investment in the face of varying environmental scenarios. Using policy-capturing methodology, we find differences between what the executives thought was important to their decision-making and what is revealed as actually being important. In addition, we find that personal characteristics of risk-taking propensity and innovativeness affect the way the decision-makers integrate information. We argue that the idiosyncratic nature of the executive-environment relationship calls for increased emphasis on developing suitably adapted decision support systems (e.g., business intelligence systems) for executive decision-making.     

How Economic Incentives May Destroy Social,Ecological and Existential Values: The Case of Executive Compensation

Executive compensation has long been a prominent topic in the management literature. A main question that is also given substantial attention in the business ethics literature—even more so in the wake of the recent financial crisis—is whether increasing levels of executive compensation can be justified from an ethical point of view. Also, the relationship of executive compensation to instances of unethical behavior or outcomes has received considerable attention. The purpose of this paper is to explore the social, ecological, and existential costs of economic incentives, by discussing how relying on increasing levels of executive compensation may have an adverse effect on managerial performance in a broad sense. Specifically, we argue that one-dimensional economic incentives may destroy existential, social, and systemic values that influence the manager’s commitment to ensure responsible business conduct, and have negative spillover effects that may reduce the manager’s performance. There are well-documented findings that demonstrate that reliance on sources of extrinsic motivation (such as economic incentives) may displace intrinsic motivation. Our perspective is a holistic one, in the sense that we will explore the influence of sources of extrinsic motivation on the manager’s intrinsic commitment to different types of values. We will in particular investigate how it may influence the manager’s ethical reflection and behavior or lack thereof.     

市场化进程、企业特征与高管薪酬—业绩敏感性

结合中国市场化改革的制度背景,就不同地区市场化进程差异对企业高管薪酬契约的影响进行理论分析和实证检验,结果发现:随着市场化进程的加快,高管薪酬与会计业绩的敏感性降低,与市场业绩的敏感性增加,这表明市场化改革的深化改变了高管薪酬契约中不同业绩指标所占比重的大小;同时,区分不同性质和行业的研究发现,市场化进程对国有企业高管薪酬—业绩敏感性的影响显著大于非国有企业,对保护性行业高管薪酬—业绩敏感性的影响显著小于竞争性行业,这表明市场化进程的宏观背景对不同性质和行业的企业高管激励契约的影响程度存在差异。     

Business Ethics – Deontologically Revisited

In this paper we look at business ethics from a deontological perspective. We address the theory of ethical decision-making and deontological ethics for business executives and explore the concept of “moral duty” as transcending mere gain and profit maximization. Two real-world cases that focus on accounting fraud as the ethical conception. Through these cases, we show that while accounting fraud – from a consequentialist perspective – may appear to provide a quick solution to a pressing problem, longer term effects of fraud and misconduct make ethical implications more apparent. Widely used compensation schemes also may have the tendency to fuel unethical behavior. We argue that an ethical reinvigoration of the business world can only be accomplished by encouraging the business realm to impose upon itself some measure of self-regulating along the lines of deontological ethics. Principles of deontology should guide executive decision-making particularly when executives are tempted to operate outside of codified legislation or are bound to act under judicial-free conditions. Carmelita Troy is an Assistant Professor of Accounting in the Graduate School of Business and Public Policy at the Naval Postgraduate School, Monterey, California. Micewski, Edwin R., Dr., Brigadier General, is social philosopher and Director of the Institute for Human and Social Science of the Austrian National Defence Academy, Vienna. Member of the Science Commission of the Austrian Ministry of Defence and Visiting Professor at the Department of National Security Affairs of the Naval Postgraduate School in Monterey, California. Research and teaching areas: Social and cultural philosophy, military ethics, (military) professionalism and leadership, postmodernism and war. Recent publication: (Ethics and international Politics (2001); Civil- Military Aspects of Military Ethics (2003/2005); Terror and Terrorism- History of Ideas and Philosophical-Ethical Reflections (2005); Asymmetry and Western Society - Culture-critical Reflections(2006).     

中国高层经理股票期权最优激励比例研究

高层经理股票期权机制将经理人员的报酬与公司的市场价值联系在一起,从而达到降低代理成本,增加社会福利的目的。目前国内关于股权激励问题的研究很多,但还存在着一定的争议,特别是关于股权激励的定量分析。本文以经济分析法为基本研究方法,辅以实证研究的方法以高层经理股票期权为内容进行了分析,针对最优期权比例的确立进行研究,通过委托-代理模型分析方法建立最优股权激励模型,并对影响最优股权激励的因素进行讨论,提出建议,以促使股票期权激励制在中国达到应有的实施效果。     

Imperfect markets: Business ethics as an easy virtue

This paper marks a radical diversion from the large body of prevailing literature in business ethics which primarily views the issue in individual-personal terms, i.e., corporate executive and employee, and suggests that making corporations more ethical would primarily come through changes in executive behavior. While this approach has strong intellectual roots in moral philosophy and religion, it fails in explaining the persistence of unethical and illegal behavior among corporations of all sizes, financial health, competitive market conditions, and, level of individual executive compensation. This paper argues for a fundamentally different approach to understanding ethical behavior, or lack thereof, among corporations and their executives. It is asserted that an overwhelmingly large rationale and/or inducement for proactive ethical business behavior is rooted in competitive aspects of particular markets, and industry structures prevailing in those markets. Furthermore, while highly competitive markets may promote efficiency, they do not guarantee ethical behavior and may indeed provide greater opportunities and incentives for unethical business behavior. Thus, by following the current prognosis, we could be wasting enormous resources in terms of teaching business ethics, and creating and imposing corporate codes of conduct. We assert that these approaches would at best make a marginal improvement in the ethical performance of corporations while at the same time exacerbate the problem by ignoring more fundamental, structural issues. Imperfect markets, with their above-market profits, are a necessary but insufficient condition for corporations to behave ethically. It is only under conditions of imperfect markets that individual executives can play an important role in guiding their corporations toward greater ethical norms. These are undertaken for a variety of reasons, including, protecting a corporation's good name, public expectations, competitive norms, and, corporate culture and individual executive's predilections, to name a few.S. Prakash Sethi is Professor and Acting Director, Center for Management, Baruch College, The City University of New York. He has widely published in the areas of corporate social responsibility, international business, business ethics, and corporate strategy and public policy. His most recent publication isMultinational Corporations and the Impact of Public Advocacy on Corporate Strategy: Nestle and the Infant Formula Controversy (Kluwer, 1994).     

The Dynamics of Guanxi and Ethics for Chinese Executives

This study empirically examines how Chinese executives perceive the role of guanxi and ethics played in their business operations. By factor-analyzing 850 valid replies collected from a comprehensive survey, the present study identifies three distinct ethics-related attitudes and two distinct guanxi-related attitudes for Chinese executives. The cluster analysis of the composite scores of these five attitudinal factors further indicates the existence of three distinct groups of Chinese executives that vary in their ethics and guanxi orientations. The three groups are unethical profit seeker (UPS), anti-governance, guanxi-cultivator (AGGC), and apathetic executive (AE). The three groups are also found to be significantly different in such demographic characteristics as age and the ownership structure of the serving organization. Specifically, the inter-group comparison suggests that younger Chinese executives, and those working for privately-owned firms and joint ventures are more inclined to engage in unethical activities for profits. These findings provide useful insights for international investors to formulate their human resource and negotiation strategies in China.     

论行政悬赏的法律性质——基于典型案例研究的视角

行政悬赏是行政主体为了达到某一目的而向不特定的人发出要约,对于接受和履行要约的人给予事先承诺物质利益的行为。这一行为目前已成为政府等行政机关越来越多使用的一种新型施政（行政）手段。但行政悬赏是一种什么性质的行为,我国现行法律并没有明确规定。司法实践中法院的处理和判决结果也不尽相同,理论界也存在几种截然不同的看法。通过对几则典型的行政悬赏案例的分析和比较,行政悬赏就是一种特殊的行政奖励。     

Can we talk about ethics anymore?

It is difficult to talk about ethics in Australia these days, because (a) the different metamoral languages make it difficult for people to communicate on moral matters; (b) there are no generally accepted criteria for assessing the meaning and truth of moral propositions; and (c) witness talks larger in these matters than theoretical expertise, and the ideals that favour the acceptance of credible role models are no longer generally accepted. We should not assume that we can say anything meaningful about “business ethics”. One reason for this arises from the Australian experience of the '80s: the fruits of a profound cynicism are now with us, as prominent figures find themselves in court to defend their actions, and seem amazed that they are accused of doing anything wrong at all. We may want to stop something like this from happening again, but if the language of business ethics meant nothing to these people, how can we hope that it will mean much to us, or to future generations? A second reason (or group of reasons) arises from the nature of ethics itself. Business ethics, after all, does not exist in a vacuum; its language will not mean much to people who do not agree on what they mean whenever they talk about right and wrong. Some people, for example, measure the rightness or wrongness of actions in terms of their consequences; for others, on the other hand, some actions are wrong, no mater what the consequences. How are they to talk to each other? What is at issue here is what ethical propositions mean, and how one can measure their truth. And there is another reason. As Socrates pointed out long ago, ethics is not a theoretical science, which can be taught and learnt as dispassionately as mathematics. It is practical, and so engages teacher and pupil in an entirely different way: one cannot say one thing, and do another. When you have read a journal like this, will you necessarily be a better person or a more honest businessman/woman?     

Corporate Governance, Ethics, and the Backdating of Stock Options

Backdating of stock options is an example of an agency problem. It has emerged despite all the measures (i.e., new regulations and additional corporate governance mechanisms) aimed at addressing such problems? Beyond such negative controlling measures, a more positive empowering approach based on ethics may also be necessary. What ethical measures need to be taken to address the agency problem? What values and norms should guide the board of directors in protecting the shareholders’ interests? To examine these issues, we first discuss the role values and norms can play with respect to underlying corporate governance and the proper role of directors, such as transparency, accountability, integrity (which is reflected in proper mechanisms of checks and balances), and public responsibility. Second, we discuss various stakeholder approaches (e.g., government, directors, managers, and shareholders) by which conflicts of interest (i.e., the agency problem) can be addressed. Third, we assess the practice of backdating stock options, as an illustration of the agency problem, in terms of whether the practice is legally acceptable or ethically justifiable. Fourth, we proceed to an analysis of good corporate governance practice involving backdating options based on a series of ethical standards including: (1) trustworthiness; (2) utilitarianism; (3) justice; and (4) Kantianism. We conclude that while executive compensation schemes (e.g., stock options) were originally intended to help remedy the agency problem by tying together the interests of the executives and shareholders, these schemes may have actually become “part of the problem,” and that the solution ultimately depends upon whether directors and executives accept that all of their actions must be based on a set of core ethical values.