Bottom-Line on CEO Compensation

In the business world results matter, especially the results that matters most to (that is benefits) ‘me’!  And there are few in a better position to be self-serving than a CEO of a large corporation.  In regards to top executive compensation life has been and continues to be good, and more importantly it looks as though this will not change in the future.

According to the precepts of the economic system CEOs of major corporations are doing what they are expected to do, maximize their material self-interest.  As the theory goes, when people pursue their self-interest then the wealth of society is enhanced.  If you doubt that there is greater wealth in society, in light of unprecedented CEO compensation, all you have to do is look at household income growth.  Though increased growth is quite concentrated among the top 1% of households, there is little doubt that there is more wealth—it’s that just a relative few have most of it.

What Matters

In business if your performance doesn’t matter then you don’t matter!  In regards to the performance of their corporation does the top corporate executive matter? Is there a meaningful cause-and-effect relationship between the CEO and the corporation’s performance? In other words is the compensation commensurate with the CEO’s contribution to the organization’s performance?

Often the competitiveness of the organization is mentioned as a criteria when asking, has the organization been competitive under his/her leadership? We can acknowledge that poor management can be disastrous to an organization’s competitiveness as long as the other competing organizations within the industry don’t similarly suffer.  However if they do, then all will be on the (same) level playing field—no disadvantage to anyone and all will be competitive with each other.  A case in point is the former Big 3 in American auto industry. Clearly competitiveness is not a sufficiently telling or discriminating measure!

Most feel leadership matters, and so of course a leader makes a difference!  But, the conclusions from the research on this issue range from (a) the CEO role is mostly symbolic to (b) CEOs have minimal impact, particularly in large corporations.

As reported in a recent Knowledge@Wharton article, the differences in firm performance among Fortune 800 companies in a recent study showed that top executives (e.g. CEO, CFO) account for less than 5 percent of the difference in an organization’s performance. In other words, 95% of the differences in firm-to-firm performance are attributable to things other than the ‘leader of the firm’.  Abraham Carmeli and Ashler Tishler seem to support this stating, “a single person, however talented, is unlikely to possess all the managerial skills that are required for the successful operation of a complex organization” (Strategic Management Journal, December 2004, Vol. 25 No.13).

Accordingly much of the attention has turned from the top person to the top group as recent research has focused on the impact of the top management team (TMT).  However, this too has yet to be conclusive since singling out one person or singling out one group is still reductionism. A major contributing factor is that Western society’s system of orientation is grounded in reductionism and dualistic thinking which supports the pursuit of the one single cause as well as the importance of and accountability for short-term results.

Not Reducible

Organizational performance is an emergent property.  Performance of a system is the result of the interaction among all the system’s elements and the environments to which it is connected.  The more the elements and the environment are in accord the greater the performance—when interactions are complimentary or positive the systems performance is enhanced.

As illustration consider for the system we call an orchestra, music emerges from the interplay of the musicians, their instruments, the conductor and the space within which they are playing; and the better the harmony among the components the more harmonious the music.   Similarly in the systems we call business organizations, performance of the system is not and cannot be attributed to a single organizational component (e.g. CEO) or to even a linear combination of select members (TMT).

Organizational performance is an emergent property, not a summative property.  It is a system property that cannot be understood through reductionism because it emerges from the whole system.  Hence we ought not manage as if reductionism applies, using such practices as pay-for-performance and rank-and-yank.

Bottom line

Paying the top person in the hierarchy disproportionately more than all other members of the system who contribute to the emergent performance of the system is: a) a sign that one doesn’t understand the principles and dynamics of systems; b) a potential cause for a decrease in motivation and collaboration among organization members; and c) a wasteful misallocation of corporate funds.

2 thoughts on “Bottom-Line on CEO Compensation

  1. Do you suppose there is a correlation between the rising number of employees who report being disengaged and the growing income disparity between the TMT and other organizational personnel? What are the effects of no credit where credit is due? Also wondering what percentage of America’s shares and options are owned by CEO’s who insist there only responsibility is to make a profit for their shareholders? Last I read 86 percent of all American shares were owned by only 2% of the American people.

  2. I suspect there could be something to your first two questions. Herzberg’s Two-Factor Theory supports the notion that content factors of one’s work life ( management, working conditions, salary, etc) are not satisfiers but rather deficit needs or dissatisfiers—they are de-motivating when not fulfilled but not satisfying when they are fulfilled. Consider also the aspect of instrumentality in Expectancy Theory which speaks to the strength of the belief that if we carryout our work we will achieve our desired outcome. That is, the notion that when we work hard and increase our productivity—and productivity per worker has increased making for highly profitable corporations of late—we will be commensurately compensated, has not proven valid thus diminishing one’s desire to do the work.

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