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Are CEOs Overpaid?

Written by Society for Industrial and Organizational Psychology (SIOP) on 17 March 2009.

Amid the current economic turmoil, the debate over CEO pay has intensified. Now more than ever, the propriety of large salaries and bonuses for CEOs is leading people to ask, “Are CEOs overpaid?”

This question is an important one, said Jerald Greenberg, senior psychologist at RAND Corporation and a member of a panel that will discuss the compensation of CEO’s at the 24th Annual Conference of the Society for Industrial and Organizational Psychology April 2-4 in New Orleans.

The panel includes four experts in organizational justice, compensation and employee motivation. “As resources become scarce, we become increasingly careful about how to spend them,” Greenberg, SIOP Fellow, said. “So, if a CEO's salary appears to be wasted, people become concerned about it.”

Edwin Locke, a retired SIOP Fellow, noted there is no set level of pay that is “fair” or that would make a CEO “overpaid.” Locke, who taught management and psychology for 34 years at the University of Maryland, said instead of thinking in terms of “is a certain amount of pay too much,” you need to look at the market.

“Fair is really, at least at the time of hiring, what the market price is,” he explained. “What’s the intrinsic value of a baseball player? What the fans are willing to pay to see a ball game.”

However, the market for CEOs doesn’t always work the way the normal marketplace works, argues fellow panelist Albert Cannella.

“That statement is much more correct if CEO salaries were established in a marketplace where there’s a lot of buying and selling going on,” said Cannella, Koerner Chair of Strategy in the Department of Management at the A.B. Freeman School of Business at Tulane University. “That would arguably be the case if CEOs changed companies frequently, and we could observe a lot of CEOs leaving their current positions for other CEO positions at higher salaries. However, this is extremely rare. The evidence suggests that CEO salaries arise from private—i.e., covert—processes that they have significant control over.”

Cannella said one of the factors leading to extremely high salaries is that CEOs often exert a huge influence over the boards of their organizations and, thus, over their own compenstion. “Boards don’t have to agree to these contracts in the first place, but they do,” he said. “A lot is done in the honeymoon period following the CEO’s hiring when everyone feels great about the person.”

CEOs also garner power because there are relatively few of them in the workforce. That puts them in an exclusive and highly paid ‘CEO Club,” where salary levels often become a form of competition among CEOs,” Cannella said.

However, that there are few CEOs, makes high pay more justifiable, Locke explained. “Good CEOs are extremely difficult to find. There aren’t that many and you have extremely high turnover.” In part, that’s because running a company is much more complicated than it used to be, he added.

The panel agreed that pay increases for executives whose companies are performing poorly is a bad idea. CEOs should be paid highly for success and not for failure, Greenberg said. However, Locke added, you need to be sure success is both long and short term.

“If the CEO makes a lot of money for the company in the short term but the company eventually fails because of poor investments, then that would be a negative long-term performance,” he said. “On the other hand if you fail in the short term, there is no long term.”

And measuring the outcomes of a CEO’s work isn’t always easy, Cannella said.
“What exactly did the CEO accomplish over the year? What value creation can be attributed to him or her? That’s very difficult to figure out,” he said.

Meanwhile, the pay discrepancy between CEOs and employees has widened over the past few decades, Cannella said, noting that the first study of CEO pay comparing this gap was done in 1986. “Back then we thought CEOs were making a lot of money, he said. “The CEO was making 50 to 60 times what the entry-level employee was making. Now it is hundreds of times more.”

But Locke said the issue can’t be looked at in terms of the pay discrepancy.

“There is no intrinsic amount of difference that there should be between the CEO’s salary and the other employees,” he said. “If a CEO is doing a good job, he might be the reason the company’s doing well and the reason employees still have a job.”

So what can companies do to make sure their CEOs salary hasn’t gone off the deep end? One option is to make CEO pay at least partially recallable, Cannella suggested. Merit-based pay is also a good concept, Locke and Greenberg said. Greenberg said incentives are an important factor in performance-based pay.

“A formula that rewards executives for what they do to bring value to the company—long-term, short-term, and ethical goals should be met—is key,” he said. “Fixed sums, such as the U.S. government's $500,000 salary to bank executives, are severe disincentives. This is a great time for paying for performance.”

The Society for Industrial and Organizational Psychology (SIOP) is an international group of more than 7,800 industrial-organizational (I-O) psychologists whose members study and apply scientific principles concerning workplace productivity, motivation, leadership and engagement. SIOP’s mission is to enhance human well-being and performance in organizational and work settings by promoting the science, practice and teaching of I-O psychology. For more information about SIOP, including a Media Resources service that lists nearly 2,000 experts in more than 100 topic areas, visit www.siop.org.

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