However, rather than paying off a bad CEO, Wharton legal studies and business ethics professor Thomas Donaldson questions why more companies don’t just fire them – making much of any promised or assumed compensation package null and void. “We fire for cause inside an organisation,” notes Donaldson, who is also director of the School’s Zicklin Center Business Ethics Research. “We should use the tool of firing for cause more often in the board room.”
Some argue that firing CEOs would make incoming executives wary of taking the job, but Donaldson suggests that the lack of firings really comes down to friendships and coziness between the board and CEO, even if the CEO has done wrong. “The problem is, it’s a lot easier to be generous,” he says.
Injustice and loyalty
Most companies that pay out exit packages upwards of $10 million, or even $50 million, can typically afford to do so, and the cost will barely make a dent in earnings. But there are other costs they risk incurring, such as a decline in company morale or a drop in stock price. “The [payouts] that get a lot of attention are usually not particularly costly to the firm,” Guay notes. “The reason they get so much scrutiny is that they happen to be paid right at the time people are fed up with that individual. And it just smacks of a sense of unfairness.”
This feeling of injustice is what can prompt employees to feel disconnected from the company. “When a package looks manifestly unfair, it sends a message to the company that the board is not really trying to get great performance for great pay,” Useem says. “In the short term, it could be fundamentally demoralising to the company.”
Additionally, such outsized packages could prompt employees to look for jobs elsewhere or give minimal effort in their current positions because they feel betrayed by their employer, notes Donaldson. “The extent that ex-CEOS are treated like an elite group that is apart from the rest of the firm really is a red flag for many employees, and it can really affect their sense of loyalty to the firm.”
When it comes to a more tangible direct effect, the impact on a company’s stock price usually depends on the circumstances behind a CEO’s exit. Taylor says that when a leader is fired after poor performance and paid a big severance, the stock price typically does not move – suggesting that shareholders saw the exit coming and are happy to see the old CEO finally out. But when the CEO leaves the firm voluntarily and gets a big exit package, the stock price typically goes down, he adds – suggesting that shareholders feel the board is making poor decisions and not working for their interests.
Regulatory changes
The peak of large CEO compensation packages came in 2002 and then came quickly crashing down after the Enron and WorldCom scandals and passage of the Sarbanes-Oxley Act, which strengthened reporting standards for public firms. The scandals also prompted a review of how executive payouts are disclosed. In 2006, the Securities and Exchange Commission issued requirements that companies disclose all benefits in financial statements if they exceed $10,000 in one year.
That move has been one of the most effective regulations when it comes to tightening exiting CEO packages, according to Guay, and it has basically gotten rid of tax gross ups — which occur when a company makes up for the difference a CEO has to pay in taxes by offering non-cash perks like the use of a private jet or moving expenses. “Shareholders do not like these types of perks,” Guay says. “And because of the recent scrutiny, tax gross ups are going away.”
More recently, the Say-on-Pay statute in the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed in reaction to the corporate excess and risk-taking that fueled the 2008 financial crash, is moving past disclosure and letting share holders weigh in on compensation. The SEC implemented the rule in January 2011, requiring all US public companies to provide their shareowners with a non-binding vote to approve the compensation of the top five senior executives. In 2011, there were 2,340 Say-on-Pay votes but only 37 companies had a majority of shareholders vote against proposed compensation packages.
While the rule might be effective at prompting boards to better explain themselves when deciding on compensation packages, involving shareholders in the decision is going about it the wrong way, according to Guay. “I think it is a little ‘pie in the sky’ to think that [shareholders] are going to get it right. They don’t have time to scrutinize everything, and they are not privy to all the inside information,” he says. “That’s why this duty has been delegated to the board.”
Still, Useem notes that public outcry has done little to change CEO compensation, and he does not think the Say-on-Pay rule will have much of an effect, especially as the vote is non-binding. “Companies have been resistant and resilient when it comes to demands from the media and government and compensation critics,” he says. “I would not hold your breath waiting to see a change in compensation for exit packages.”
