Reference no: EM132634177

Case Incident

Few topics in the business press have grabbed more headlines recently than highly lucrative annual bonuses for top management. Critics bemoan the multimillion-dollar compensation packages offered in the financial services industry in particular, following the dire consequences of the meltdown of this sector a few short years ago. How is executive compensation determined by compensation committees? Some researchers suggest that principles from equity theory (making comparisons to referent others) might explain variations in executive pay. To set what is considered a "fair" level of pay for top executives, members of the board find out how much executives with similar levels of experience in similar firms (similar inputs) are being paid and attempt to adjust compensation (outcomes) to be equitable. In other words, top executives in large oil firms are paid similarly to top executives in other large oil firms, top executives in small hospitals are paid similarly to top executives in other small hospitals. In many cases, simply changing the referent others can change the salary range considered acceptable. According to one view of justice theory, this should be perceived as equitable, although executives may encourage boards to consider specific referent others who are especially well-paid. Critics of executive compensation change the debate by focusing on the ratio of executive compensation to that of the company's lowest-paid employees. Researcher Cary Cooper notes, "In business, it is important to reward success and not simply status." Cooper believes all employees should share the company's good fortune in profitable periods. He has recommended that CEO compensation be capped at 20 times the salary of the lowest paid employee. In fact, the average S&P 500 CEO is paid 263 times what the lowest-paid laborer makes. This is eight times more than the ratio from the 1950s, which might serve as another reference point for determining what is considered "fair."

Questions

a. How does the executive compensation issue relate to equity theory? Who do you think should be the referent others in these equity judgments? What are the relevant inputs for top executives?

b. Can you think of procedural justice implications related to the ways pay policies for top executives have been instituted? Do these pay-making decisions follow the procedural justice principles outlined in the chapter?

c. Do you think the government has a legitimate role in controlling executive compensation? How might we use distributive and procedural justice theories to inform this debate?

d. Are there any positive motivational consequences of tying compensation pay closely to firm performance?