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Markkula Center for Applied Ethics

Executive Compensation

Margaret Steen

Executive compensation has been in the news as part of an ongoing discussion of income inequality. But as James O'Toole, the moderator of a panel called "Executive Compensation" at a recent meeting of the Business and Organizational Ethics Partnership at Santa Clara University's Markkula Center for Applied Ethics, said, there is a question as to whether a problem even exists. Are executives paid what they're worth, or too much?

In addition to O'Toole, senior fellow in business ethics at Santa Clara University and former Daniels Distinguished Professor of Business Ethics at the University of Denver's Daniels College of Business, the panel consisted of Leslie Denend, former CEO of Network General, former chairman of the board at Verifone, and former board member at Exponent, McAfee and USAA; Tim Sparks, founder and president of compensation consulting firm Compensia; Edward Lawler, Distinguished Professor of Business and director of the Center for Effective Organizations at the University of Southern California's Marshall School of Business; and Donna Morris, senior vice president of global people and places at Adobe.

O'Toole started the panelists out by asking how we evaluate corporate leaders. Is the sole criteria the extent of wealth created for shareholders? Or should they also be judged by the way they produce those profits? Similarly, should CEOs be paid solely based on the company's performance, or are there fairness and other issues to consider?

The panelists took turns giving their perspective on these initial questions and then continued the discussion.

Morris looked at the issue from the point of view of a practitioner. Compensation, she said, is both an art and a science.

"Ultimately we're an IP-based business," Morris said. "The core asset that we have goes home every day. Rewards are as important to a bright new grad as to the executives that work for us."

Lawler said he started studying pay 50 years ago. "The gap between the lowest and the top has escalated enormously – this is a long-term trend," Lawler said.

It's a complex issue, he said, and can be looked at from the shareholders' point of view or from the perspective of sustainability. "Things are going better from the shareholder perspective than for sustainability," Lawler said.

Sparks said the demise of stock options and the emergence of performance-based equity compensation have driven a lot of changes, especially in the tech industry, in recent years. These trends can be traced to changes in the accounting treatment of different types of equity compensation.

One question that has arisen is how to disclose executive pay when it's not clear how much equity the executive will actually receive, since that will be based on performance, or how much it will ultimately be worth.

Denend laid out five points for creating ethical compensation packages, from the perspective of a board member. First, board members need to understand the context and expectations of the work they're taking on. Board members are expected to be independent and devote enough time to the work, for example. Second, board members should take the shareholders' perspective. "Every dollar you don't pay" in compensation is available to be distributed to shareholders, he said.

A third point, Denend said, is to make sure the pay is fair. This often means making sure people doing similar jobs are paid the same, though he said it's difficult because all boards want to judge that their management team is above average. A second way to look at fairness is from top to bottom: Among companies in the same peer group, how much compensation goes to the CEO, how much to the CEO's direct reports, and how much to everyone else?

Denend's fourth principle was paying for performance, though he noted that "the devil's in the details." The connection between pay and performance is not fully understood, he said, but "it's not always as direct as you think."

Finally, Denend said board members need to use good judgment and get advice: "Sometimes when the numbers argue that you do one thing, step back and say, 'What's the right thing to do?'"

Margaret Steen is a freelance author.

Nov 30, 2015