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Summary of Case:

In any organization, compensation is the key factor for an employee to get satisfaction. So,
employees more concentrate on their salaries, based on this motivation and input level will
varies. Similarly deciding salaries to top management is tough task to compensation
committee. But it creates huge differences while comparing with low-level employee. Based
on the equity theory the compensation is decided, but the critics from cooper will make
committee to think about the success of firm not the status. Where the pay ratios which
created from 1950s make into eight times more than its ratio will make these determinations
as “It's Not Fair”.

Facts:
How fair is deciding the pay to Top-Management?

As per the case, the top management people were highly payable by the firm. By the cooper
words, the compensation to top level is 20 times more than the low-level employee. But, the
critics says that it is eight times more than its proportion of 1950s, that which misleads their
pay into inequitable. Indeed of their job role, responsibility, revenue and success their salary
raises up. Because of that reason this case can be called as “It's Not Fair”.

Compensation is determined by EQUITY theory

Many of the researchers /compensation committee follow the equity theory to regulate the
chief executives pay. It discuss the how much an individual will puts his inputs to get the
output that which compares with other input and output levels. 1ere hard work, commitment,
loyalty etc., are towards the job which says as input and the salaries, recognition, reward etc.,
are called as output. As per this theory employee get distorted when it possess inequitable
levels between input and output levels.

Comparison with other firms compensation

The given information says that board members are suggested to decide the compensation by
comparing with other firms, which possess similar inputs and levels. Based on this, the pay is
fi0ed to make the employee in a positive inequity manner. In that, one should feel that he/she
are over rewarded on a company to others. By comparing the top management of large firms
with similar type of large firms and smaller firms with similar type of smaller firms.

For compensation, success is the key factor not status

The debate rises on inequity proportions of compensation to superior employee, not bothering


with the firm's success. Some of the critics, says that based on the profits of the company the
rewards can be distributed to the employee regarding to their inputs. Here, the importance is
given to their efforts not to their positions. By this nature, the employee can be motivated to
firm's growth and success.

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Introduction

Each time I have found myself mentally stomping my foot, claiming that "it is not fair," I
have been miserable. Yet when I am willing to step back and allow the Holy Spirit to make
what my husband, the therapist, would call a "cognitive restructuring," and I take the focus
off myself and truly love Chuck extravagantly -- thinking of what is best for him and for our
marriage, not what is best for me--my misery lifts. I find myself looking back and wondering,
"what was I so unhappy about?" It is amazing how God's plan really does work! I have made
Ephesians 5:1 & 2, from The Message, my marriage mission statement: "Observe how Christ
loved us. His love is not cautious but extravagant. He didn't love in order to get something
from us but to give everything of himself to us. Love like that."

 In boom or recession, a company is growing or surviving not by default but by


effective strategies .This strategic decisions are taken by CEO.
 The compensation program serves three main purposes.
o It must attract executives with the skills, experiences, and behavioral profile
necessary to succeed in the position.
o It must be sufficient to retain these individuals, so they do not leave for
alternative employment.
o It must motivate them to perform in a manner consistent with the strategy and
risk- profile of the organization and discourage self-interested behavior.

Elements of Compensation
The compensation package includes some or all of the following:

• Annual salary - Fixed cash payment made evenly over the year.
• Annual bonus - Additional payment (usually cash) awarded if performance exceeds
predetermined targets.
• Stock options - Right to buy shares in the future at a fixed exercise price, generally
equal to stock price on the grant date.
• Performance units (shares) - Cash (or stock) granted if specified targets are met over a
three-to five-year period. Size of the award is generally expressed as a percentage of
base salary. Performance units are similar to a longer-term version of the annual bonus.
Perquisites Other amenities purchased or provided by the company (such as personal
use of company airplane).
• Contractual agreements - Other cash or stock payments stipulated in the employment
agreement, such as severance, post-retirement consulting, and change-in-control
payments (“golden parachutes”).
• Benefits - Other benefits such as health insurance, post-retirement health insurance,
401(k), supplemental executive retirement plans (SERPs), life insurance, payment for
use of financial planner, and certain tax reimbursements.

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Facts of Case Study
• How is executive compensation determined by committees?
• Principles of equity theory.
• Comparison with peer groups (other firms of same industry).
• Critics of executive compensation.
• Researcher Cary Cooper.
• Average S&P 500 CEO.

Designing the Compensation Program


• The compensation committee recommends compensation of the CEO and other
executive officers.
• Packages are approved by independent directors of the full board. Shareholders
approve equity-based compensation.
• Most boards benchmark CEO pay against a peer group of companies comparable in
size, industry, and/or geography.
• There are potential drawbacks to benchmarking:

– Might lead to ratcheting.

– Is based on size rather than value creation.

– Is highly dependent on companies included in peer group.

Companies include unrelated firms in peer group, and the inclusion of these firms tends
to increase pay.

Ratio of CEO Pay and Average Employee Pay


• CEO Compensation is 20 times the salary of the lowest-paid employee.
• In an average 500 CEOs are paid 263 times what the lowest paid laborers makes.
• It is 8 times more than the ratio from the 1950s.
• Results are based on:

-industry, size, location and workforce composition

-expected vs. realization

-mean vs. median calculations

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Questions and Answer:

1. How does the executive compensation issue relate to equity theory?


Who do you think should be the comparative others in these equity
judgments? How should we determine what is a “fair” level of pay
for a top executive?
The executive compensation issue relates to equity theory because aspects of equity theory,
like referents, are used to determine the compensation amount for executives. The referent
others should be other executives in similar businesses. I think the business being compared
has to be similar in not only the same concept but also the same type of location and success
level. The referent chosen to compare should also have the same gender type position.
According to the textbook, “employees in jobs that are not sex segregated will likely make
more cross sex comparisons”. Equally, same sex positions will make comparisons
accordingly. Some relevant inputs for top executives are education, level of experience and
competence:

Equity Theory

 Employees weigh what they put into a job situation (input) against what they get from
it (outcome).
 They compare their input-outcome ratio with the input -outcome ratio of relevant
others.

The executive compensation issue relates to the equity theory most of the times, as
compensation calculation procedure in most of the organizations, especially MNCs, is based
on reference compensation from the market.

The compensation comparative procedure for equity judgment is based on the following:

 Company performance
 Company targets achievement
 Comparative compensation with in competitors
 Comparative compensation with other organizations of similar size/structure

To determine a fair level of pay for a top executive education, experience, previous
organizational outcomes tied to the CEO’s performance should be considered.

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2. 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?
Procedural justice is defined as the perceived fairness of the process used to determine the
Outcome.

Yes I think in mostly organization performance evaluation process exists, which follows
same rules and regulations for rest of the organization. So pay making decisions follow the
procedural justice principles.

But there is a check, as top executives reserve rights to supersede the policies and procedure,
though it is not considered as good practice, but still this option may be usable for bypassing
procedural justice in few organizations.

3. 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?
Yes Government has a legitimate role in controlling executives’ compensation by regulatory
authorities for different organization types. It should follow the procedural justice:

 The increment percentages sets should have minimum and maximum level as per
standards.
 Similarly perks and bonus slabs are well defined.
 Performance based slabs should be defined.
 All organization follows same standards.
 Any exception should be re-visited by regulatory authority for executives.

4. Are there any positive motivational consequences of tying compensation


pay closely to firm performance?
Yes indeed, there are positive motivational consequences of tying compensation pay closely
to firm performance.

Tying compensation pay to firm performance motivates the individual to work hard to
achieve the reward. This relationship is defined in the performance-reward relationship.

 Individually: yearly increment and bonus links with yearly goal achievement of an
individual. Throughout the year individuals strive to archive self-goals and hence it
leads to individual motivations

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 Team: Similar to individual, goals of a department are linked to company goals and
tied with appraisal process
 CFT: New concept of tying multiple cross functional team with same goals and
additional bonus to achieve maximum performance with motivated teams (like
Collaborative for Business and Operations Management).

Recommendations
 Compensation should Drive Company and Individual Performance
 Balance Short-Term and Long-Term Performance Demands
 Link incentive compensation to Company results over the fiscal year, and delivering it
partially as long-term awards that are linked to multi-year performance
 Retain Key Talent and Protect the Company’s Interests
 Cancellation provisions to encourage executives not to leave the Company for a
competitor and to protect the Company’s interests
 Claw back provision if an individual engages in certain conduct detrimental to the
Company
 Eliminate controversial compensation practices that conflict with the notions of
fairness and pay for performance
 Demonstrate credible board oversight of executive compensation
 Shareholder’s say should be increased in the process.
 Foster transparency in compensation practices and appropriate dialogue between
boards and shareholders

Conclusion
As per the case study the CEO’s should be given compensations on the basis of their
performance rather then there status. In past there are cases where the CEO’s of big company
has been paid high instead of their weak performance. The best way to deal with problem
should be that, the “Employee evaluations”. If employees are granted the power to evaluate
their fellow employees, then the system will typically be viewed in a fair and favorable
manner. And the conflict can be resolved.

 “Executive compensation is the acid test of corporate governance” – Warren Buffet


 To pass this acid test a company will have to do a fine balancing act to satisfy all the
stakeholders involved
 Balance the need for a competitive compensation program for executives with the
performance, governmental and societal considerations.

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Appendix

Case Incident: It’s Not Fair!


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

1. How does the executive compensation issue relate to equity theory? Who do you
think should be the comparative others in these equity judgments? How should we
determine what is a “fair” level of pay for a top executive?
2. 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?
3. 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?
4. Are there any positive motivational consequences of tying compensation pay closely
to firm performance?

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