The Hutton Analysis of Fair Pay in the Public Sector - Essay Example

?Order 531256 Topic: “The Hutton Review of Fair Pay in the public sector. Do you believe it would be desirable and/or possible for limits on executive pay to be applied to the UK private sector as well?” Introduction When it comes to rewarding business executives, De La Porte and Pochet (2002) note that the issue is not their excessive pay, but whether how they are paid has helped lead to some of the impressive corporate performance in recent years. They further observe that limiting the stock and stock options in incentive reward plans for executives can substantially help rectify the problem of executives being paid for temporary growth at the expense of the continuing health of their companies (qted in Kroll, 2005). For this reason, James (2009) argues that executive rewards plans should lead to policies that are simple, transparent and focused on creating and sustaining long-term shareholder value. Some studies argue that incentive reward plans should be open and easy (Kroll, 2005). But most significantly is that, executives should be constrained from selling their stock or stock alternatives for a given period after their retirement. Compensating executives in this method will offer an incentive for them to manage businesses in shareholders’ longer-term interest as observed by James (2009). This will also help reduce their motivation to control earnings or agree to unwarranted levels of risk for the sake of short-range price appreciation. At present, the concern is that majority of executives are paid excessively at the expense of the investor. Thus the current reward arrangement in my views is not in line with business culture whose whole inspiration is to increase shareholder value (James, 2009). Discussion Majority of executive payment plans principally comprise of two parts. The first part is cash compensation while the other part is incentive compensation which comprise of stocks, stock alternatives and a number of other forms of securities (Blinder, 1999). The reason behind incentive compensation arrangement as the term proposes is to offer incentives to these top managers and at the same time create value for the investor. This is attested by Kroll (2005) who notes that when the corporate value increases, the value of the shares increases for both the executives and the investor. According to Scharpf (1988), traditionally incentive compensation from stock and stock alternatives was frequently seen as a means to improved corporate performance before the wave of accounting scandals that started with Enron. To date, stock and stock alternatives compensation has been noted as the most substantial component of executive pay for quite some time (Kroll, 2005). Recent reports show that most government has rallied behind the incentive function of executive compensation in handling the issue of executive pay limit (James, 2009). Hodson and Maher (2001) however, argue that some latest accounting scandals have renewed executive compensation as an issue. This is because the executives of scandal-ridden companies have shown profits in the range of billions of dollars from exercising stock options before their companies were grounded as reported by Blinder (1999). There should be compensation plans which reduce the perverse incentives to manipulate or emphasize short-term stock prices at the expense of long-term value. Yet the benefits of equity-based incentive compensation arrangements must be maintained as stressed by De La Porte and Pochet (2002). According to (2005), executives with longer horizons are less likely to engage in imprudent business or financial strategies/short-term earnings manipulations when the ability to exit before problems come to light is significantly reduced. The concept of using restrictive stock for executive incentive compensation is not new, but rather an approach that has been lost in the current populist demands to reduce rather than redesign incentive compensation (Greenfield, 1999). In deed, majority of companies already have restricted stock plans. Most plans according to Hodson and Maher (2001) allow executives to sell these shares a few years after they are awarded. But at the same time, De La Porte and Pochet (2002) and Greenfield (1999) would require executives to hold these shares for a period of time after their retirement. In this way, both benefit investors and executives will reap the benefits in the long term. It should be noted that this suggestion is not directed at garnering executives support, but geared toward looking out for the interests of the investors (Blinder, 1999). Getting executives capable of motivating employees, communicating vision and taking business to the top can be demanding. With apprehensive shareholders closely monitoring firm performance, business organizations are under massive pressure to retain talented executives once they employ them. Without doubt, a firm with a clear vision, exceptional ideas, or an innovative product/service has a greater chance of attracting qualified persons at all levels (James, 2009). To keep the momentum going, it is nevertheless essential to get top talent at the management level. De La Porte and Pochet (2002) thus say that executives are usually attracted by a unique and demanding opportunity rather than by merely an attractive compensation package. Kroll (2005) argues that application of executive pay limits can be harmful to recovery of a firm. His argument is based on the fact that a limit on executive pay may make it more difficult for troubled organizations to sustain or acquire best talent. If such firms lack such talent, then they will continue to go deeper into trouble. Conversely, if a firm is able to maintain or acquire best talent, then its chances of improving are better. Therefore, organizations should not limit executive pay (Kroll, 2005). However, there are some problems with this idea, mainly resident in its ethical aspect. Owing to the weakening economy and the fact that jobs are being lost, it appears rather selfish of managers to desire such exaggerated compensation (James, 2009). While it is logical to argue that individuals “who can make more elsewhere will go elsewhere”, this does raise some interesting concerns. Since individuals are influenced by money, the claim in favour of unlimited pay for executives is that organizations will need to provide more pay so as to get the best talent (Greenfield, 1999). This certainly assumes that individuals are primarily influenced by money. It also presumes that the best talents expect high pay and that such individuals will not offer their skills for anything less (Blinder, 1999). Scharpf (1988) further indicate that the cost of retaining top talents definitely puts a strain on troubled firms. If such individuals do earn the firm considerably more than what they themselves get, then their compensation would be justified. But since such a situation does not exist in real life, Kroll (2005) suggests that by using reward packages which focus on executives’ attention toward increasing investors’ wealth has resulted in workers enjoying greater job and retirement security than large pay. Other studies also reveal that the linking of executive compensation to the economic performance of the company has contributed to improving the global competitiveness which, in turn has increased the economic advantages for all (De La Porte and Pochet, 2002). Conclusion Document evidence shows that executives are paid up to more than 400 times the pay of the average employee (James, 2009). Since executives are chosen for the talent and vision they bring to a company, Kroll (2005) observes that they merit their higher pay because of the qualities they have in foreseeing the different economic and technological transformations that affect business. Based on this argument, majority of executives of corporate have their pay tied to the value of their company’s stock. However, De La Porte and Pochet (2002) note that this type of pay has a downside because it may encourage some CEOs to make risky decisions so as to drive up the value of their organization’s stock. The recent economic downturn was driven by the sheer drop in real estate prices as highlighted by James (2009). Executives of most of the lending organizations speculated that most of the risky loans they endorsed would be compensated by the increase in home prices that existed in various parts of the world. This was not so because most of the executives in these organization were taking home millions of dollars annually. Moreover, Kroll (2005) reports that majority still continue to get hundreds of million dollar pay after their companies received billions in federal government rescue money to avert them from entering bankruptcy. Executive pay limits need to be applied on the rewards of executive managers, even though these should be ascertained by the organization’s board of directors and not the government. Additionally, Kroll (2005) indicates that pay should be based on the performance and should not be guaranteed. If the company performs well, then the executive’s pay should be raised. Conversely, if the company performs poorly, the executives are then supposed to take a cut in their pay (James, 2009). There is nothing unusual in paying an executive a good pay if he enables the organization to be profitable. In a nut shell, the company’s directors should ascertain the executive’s pay although they should always keep in mind that they ought to represent the best interests of their investors. Unfortunately, big, guaranteed compensations fail to achieve this goal (De La Porte and Pochet, 2002). Indeed, an executive’s basic pay should not have to exceed one million dollars annually as suggested by James (2009). The executive can then earn extra compensation if the organization posts a good performance. Otherwise, if the firm’s profit/loss falls below what is anticipated, then the executive should either expect to get a cut in pay or be fired. Bibliography Blinder, A. S. (1999) Economic Policy and the Great Stagflation. New York: Academic Press. De La Porte, C., and Pochet, P. (2002) Building Social Europe through the Open Method of Coordination. Peter Lang, New York. Greenfield, J. (1999) ‘Study finds inequities in CEO Pay, worker pay, profits’, The Working Staff Journal, Volume 2, Issue 8. Hodson, D., and Maher, I. (2001) ‘The Open Method as a new mode of governance: The case of Soft Economic Policy Coordination’, Journal of Common Market Studies, Vol. 39, No.4. James, F. R. (2009) ‘Executive Compensation Trends for 2009: Balancing Risk, Performance and Pay’, New York. Kroll, M. (2005) ‘CEO Pay Rates: U.S. vs. Foreign Nations’. Scharpf, F. W. (1988) ‘The Joint-Decision Trap. Lessons from German Federalism and European Integration’. Public Administration, Vol. 66, No. 2. pp. 239–78. Read More