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CORPORATE GOVERNANCE: EXECUTIVE PAY MUST BE TACKLED TO REBUILD TRUST IN BUSINESS

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CORPORATE GOVERNANCE: EXECUTIVE PAY MUST BE TACKLED TO REBUILD TRUST IN BUSINESS

Article Summary

Tovey (2016) explores the current debate over what is perceived to be excessive executive pay in businesses. The article discusses why various groups there is distrust in businesses due to the widening pay dispersion. Executive pay has come under scrutiny in the recent years, and this calls for a need to restore public confidence in executive pay. An investor group has opened a challenge to organizations over excessive executive pay. The investor group presented ways of rebuilding public trust over the executives’ high levels remuneration. They include choosing a remuneration that is appropriate for a company’s strategy and business needs, the board should be appropriately engaged during the remuneration process, remuneration committee to exercise independent judgment among others. Furthermore, Investment Association declared that it was necessary to simplify pay structures of the company executives and try to align shareholders interests with those of the business. Shareholders engagement should emphasis on the remuneration structure and be clear with the company on their views regarding the remunerations.

This year has seen the rise of rebellion from the investors over pay as well as the association of the working group whose aim is to handle the shareholder’s opposition over the unjustifiable boss remuneration. There is a need to restore public confidence as many reports have indicated that shareholders, the board, and executive noted that the current strategies were no longer working. The current plan aims to ensure the board clearly explains why there is a huge difference in remuneration package between the chief executive and other employees, which is a multiple of some employees.

This issue has also attracted the attention of the prime minister, who is against corporate bosses excessive pay. There is a need for clarity on how pay goals are set and why discretion is used to award remuneration. The investor report has called for deserting the previously used three-year «long-term incentive plan» model because it does not reflect how businesses work. The new plan should be able to scrape back payouts. The Investment Association proposed a binding shareholder vote on the bosses pay if the company does not secure a 75% of support from the investors. The prime minister intervention shows that company and investors should work together and address bosses remuneration that has resulted in the lack of trust among the public. This statement was also backed by the Financial Reporting Council noting UKs strong corporate governance is being tarnished by companies that do not recognize legitimate shareholder and public concerns on remuneration.

Corporate Governance issue raised: Rebuilding Trust

Concerns about the responsible use of corporate powers remain high in corporations in every industry. With the increasing rates of unemployment, the government and the public are outraged with disparities in the pay between an executive and average workers. Unfortunately, the continuous inconsistent in alignment between the remuneration of the senior executive and employees has led to the lack of public confidence (Treanor 2016). This continues to be evident despite increasing regulations to improve transparency and accountability. As a result, investors and politicians are lining up to give the shareholders a greater control over the executive pay. This is a major step in increasing the shareholder democracy, but rather than solving problems with executive pay; it may result in unintended consequences. Such issues continue to undermine investors’ confidence and fuel public distrust. Tokey (2016) noted that UKs complex and ineffectual pay regime is one of the major cause of lack of trust. This increases the scrutiny of board decisions and corporate actions that may affect regulatory environment where those companies compete. Tovey (2016) noted that executive pay must be tackled by all the corporate governance participants including the government, investors, shareholders and executive officers because they have an interest and a role to play in rebuilding trust in businesses that are the engine of our economy.

One key measure that should be considered is ensuring that the boards explain how remuneration packages are chosen for key executives in comparison to other employees. There is a wide gap in remuneration packages; the boss receives a multiple of the pay of lowest paid employee in the organization. Wide pay dispersion is considered a disputed topic with some arguing that it may positively affect firm performance while others believe it has negative impacts (Dymond 2011). Proponents of wide pay dispersion argue that it reflects firm interests in rewarding its workers based on their performance (Gerhart & Rynes 2003), based on the assumption that pay motivates the staffs to work better. According to (Lazaer 2000), pay gap may improve workforce quality by enhancing quality and encouraging them to worker harder to achieve huge pay. However, this articles emphasizes the broad pay dispersion has a negative impact on shareholders trust. Tovey noted that the executive pay is a multiple of what lowest paid employees in the company receive. With such a huge pay differential, such employees would consider their pay to be unjustifiable and react negatively. Similar sentiments were raised by the Prime Minister, who was against public corporate bosses who are favored by policies that work for a privileged few, and forget the shareholders. In fact, wide pay disparities are viewed by the employees as a company does not value their efforts (Pfeffer & Langton 1993). In another word, huge executive remunerations hurt the firms’ performance by demotivating the employees (Bloom & Michel, 2002). Research studies have shown that wide pay dispersion between senior executives and least paid employees created by organizations pay structures may influence the worker’s attitudes and behaviors (Shaw, Gupta & Delery 2002).

However, the working group has recognized that one of the biggest obstacles to change in executive remuneration lies in the breakdown in trust between the remuneration committees and the shareholders. It is clear that the current system of remuneration is not actively followed by some companies that have gone against the best practice, compromising shareholders trust. New recommendations have been introduced to prevent the poor practices reoccurring, and those companies that fail to adhere could face penalties. Investors are cautious to prevent inappropriate pay as it could cause public distrust; however, this is inflexible. For flexibility to be ensured in the system there is a need to gain public trust where it has been lost to clear investors’ doubts about supporting the companies who use a different approach (Boren 2015). The remuneration committee should also feel the investors’ engagement and will to listen to their argument regarding an alternative remuneration structure. Trust is thus crucial so that the shareholders can accept and the compensation committees can air alternative approaches that can be used.

Rebuilding Trust: A Critical Issue

Trust makes the economic transaction easier and efficient, yet the public does not trust these businesses. The executive greed has seen a major cause of financial crisis, and it saw that the current strategy to cap the remuneration packages. Tokey (2016) noted that investors suggested for the abandoning of the currently used three-year «long-term incentive plan» model, as it does reflect how businesses work and thus new models are necessary that can claw back payouts. This level of authenticity is what larger firms often struggle to their shareholders as well as employees. The wide pay disparity has created a huge issue leading a lack of trust in business. A healthy organization culture is necessary if a firm want to ensure long-term success.

The wide gap in remuneration between the senior executives and the employees sends a wrong message throughout the organization, weakening loyalty and eroding the talent pool (Owen 2009). It is evident today that executive pay has continued to grow due increased use of incentive pay such as bonus and stock options. Although, it is argued that senior executive is worth huge compensations, the effective of these pays is detrimental to the corporate life. First, the huge compensations of the senior executives affect the workers. Studies have shown that increasing inequity between senior executives and other staffs has lead to increased employee turnover. High employee turnover is an additional cost to the firm as it robs the company of valuable experience that new staffs may take years to develop. Excessive executive pays lead to an increased wage bill, the money that has been given to the shareholders.

Furthermore, the negative impacts of excessive executive pay trickle down to affect the low-level workers. When the boss gets huge bonuses, and the company is not performing well, the staffs will feel comparatively underpaid. As a result, the workers feel demotivated, and this may increase allegiance to the union. Most importantly, most companies where the senior executives are overpaid, the executives under them are more likely to be overpaid, which increases the cost to the shareholders. However, the employees at the low levels receive low pay, and this has resulted to the widening of the remunerations between the boss and low-level workers. Tovey suggests there is a possibility that an executive is paid a multiple of what least paid employees receives. A study by the American Federation of Labor and Congress of Industrial Organizations indicated that senior executives of Americas largest companies earn approximately more than 300 times the average employee pay (Liberto 2011). An average American employee earned approximately $46,742, while a standard executive earns about $12 million for a similar period. It is unbelievable that the corporate boards have bought the idea that they are paid according to their performance. The investors need to handle this issue. Judgment about fairness permeates an organizational life, and thus there is a need to restore confidence in executive pay and transparency and how to pay goals are set and explanation why discretion has been used to award them (Owain 2016). Media outcry is substantial evidence attesting to the powerful and malicious impacts of unfairness that exist when awarding the remuneration packages. Research studies have shown that when employees are assigned to a lower level, their performance decreases, and vice versa (Bucciol, Foss & Piovesan 2012). A wide wage gap is associated with a decrease in productivity, reduced team cohesion, low quality and increased cases of theft. The wide remuneration gap between the senior executives and low-level employees increased the tendency for the public to believe there exist more inequality than it does, which can intensify negative effects. Therefore, the board should see that executive pay is a critical issue that should be tackled if the company wants to rebuild trust (Fredrickson et al. 2010). When the remuneration is excessive, this should raise a red flag because the company exists to benefit the shareholders, not the insiders. The firms that issue huge amounts stocks and options to cover excessive executive pay, in the end, dilute the wealth of the shareholders (Minow 2012). On that note, it is clear that shareholders and investors are treated unfairly by those appointed to manage their wealth.

Conclusion

It is clear there is a perceived huge gap between executive compensation and that of the workers and society from which company bosses need consent. There arise a sense of unfairness that may result in an imbalance in the relationship between executives, employees, and shareholders which can undermine the level of trust in business, particularly when companies need to grow and create wealth for the shareholders. To rebuild trust, the corporate boards must develop remuneration structure that rewards all the workers fairly, and the process is consistent. This strategy will focus on creating long-term value and give the board a way of defending their policies. Leadership is thus necessary to build trust with the stakeholders, staffs, and investors. Trust is of particular concern to achieve the long-term interests of the company and its shareholders.

To solve the executive pay issues, the remuneration committees, and the board should realize that shareholders are relying on them to show the limits to the executive pay. The shareholders have shown they are sensitive to pay level, and the compensation committee should consider the shareholder and the public perception of the company’s executive pay program including how the pay goal is derived. There should be a clear explanation of the company’s compensation policy and how the pay is aligned with performance in clear terms and include key stakeholders to give their position on the remuneration packages. If the proposed compensation structure fails to receive a majority of votes, the board should consider the shareholder’s concern to determine whether the changes will be beneficial.

References List

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Boren, ZD March 2015, Excessive executive pay threatens British business, say business leaders, Independent, viewed <http://www.independent.co.uk/news/business/news/excessive-executive-pay-threatens-british-business-say-business-leaders-10080832.html>

Bucciol A, Foss N J, Piovesan M, 2012, Pay dispersion and work performance, Harvard Business School Research Paper Series.

Dymond J 2011, Getting the balance right: the ratio of CEO to average employee pay and what it means for company performance, London: Hay Group.

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Minow, N 2012, Executive Decisions: Why CEO pay spun out of control, The New Republic.

Owain T July 2016, Exec pay reforms promote flexibility and transparency, HRD Connect, viewed https://www.hrdconnect.com/2016/07/27/exec-pay-reforms-promote-flexibility-and-transparency/

Owen, D 2009, The Pay Problem: What’s to Be Done About CEO Compensation, The NewYorker, 58.

Pfeffer, J, & Langton, N1993, «The effect of wage dispersion on satisfaction, productivity and working collaboratively: Evidence from college and university faculty», Administrative Science Quarterly, vol.38, no.3, pp.382-407.

Shaw J D, Gupta N & Delery J E, 2002, «Pay dispersion and workforce performance: Moderating effects of incentives and interdependence», Strategic Management Journal, Vol. 23, pp.491-512.

Tovey, A July 2016, Executive pay must be tackled to rebuild trust in business, says powerful investor group, The Telegraph, viewed <http://www.telegraph.co.uk/business/2016/07/26/executive-pay-must-be-tackled-to-rebuild-trust-in-business-says/>

Treanor, J July 2016, Excessive executive pay has hurt public trust in business, says report, The Gurdian, viewed <https://www.theguardian.com/business/2016/jul/20/excessive-executive-pay-public-confidence-business-frc-report>