We’re all in this together – but I need more…

‘It’s very difficult for me as president to call on the American people to make sacrifices to help shore up the financial system if there’s no sense of mutual obligation and mutual help… We’re all in this together’

US President Barack Obama, March 2009

As the recession hits western countries in particular, governments are seeking to balance budgets through a series of fiscal measures; cutting government expenditure and raising taxes. In addition, wages have been frozen (or cut in real terms), pension conditions changed and employment protection reduced. To justify these policies, governments have tried to create the impression, that although the measures are tough, they are necessary and fair. In short, all the population are taking a ‘hit’ and as President Obama claims, ‘we are all in this together’.

However, at a time when economies stagnate, shares values fall and company profits are squeezed, the wage differentials between company executives and those lower down the pecking order are widening and it appears that the hit is not quite as fair as governments want their populations to believe. The biggest pay packages seem to keep getting bigger, according to research of executive compensation at major US public companies. Although there was a only a modest 2% increase in median salaries in 2011, this followed a 27% increase in 2010, which saw executive rewards climb back toward pre-recession levels.

The growth of performance-related pay has added to the complexity of remuneration packages. In the recent past, executives received only a basic salary supplemented with an annual cash bonus; now they also have share-based incentive plans. Indeed, total earnings in 2011 were boosted by a 70% increase in pay-outs under incentive plans and share option schemes.

There are some high profile examples of massive CEO remuneration packages. The highest paid top executive is Apple Inc. chief executive Timothy Cook, who succeeded Steve Jobs in August and earned $378 million in total compensation last year, one of the biggest pay packages in memory. Cook received more than quadruple the amount of the top paid chief executive in 2010, when Viacom Inc. head Philippe P. Dauman topped the list at $84.5 million. Cook’s package consisted of salary, perks and bonuses and a one-time stock award ($376.2 million) that extends over 10 years.

In the UK, CEOs at FTSE 100 companies saw their median earnings rise 32% last year, treble the rise in share prices and well above workers’ average 2% pay award, according to MM&K, a reward consultancy. Executive packages have more than doubled in value, while share prices have barely changed. FTSE 100 chief executives’ pay was 47 times that of average employees in 1998, but had risen to 120 times by 2010. The high pay commission says the top 0.1%’s share of income is back to 1940 levels and is heading towards those seen in Victorian times.

These remuneration changes are the latest illustrations of a 30-year global trend towards inequality, which has taken the pre-tax income of the top 1% in the US from 8% of the total in 1974 to 18% in 2008; what commentators are calling a “trickle-up” economy.

When firms and executives are asked to justify huge reward packages and increasing differentials, they invariably say that these are to ensure firms are able to recruit the best talent and retain high performing executives. High salaries, they say, reflect market rates for scarce talent and are a reward for the responsibilities and hours put in by senior executives and also reward achievement in increasingly large corporations. In other words, without such salaries executives would be less loyal and less motivated. The question the public are asking, however, is why senior executives need so much more than the rest of the population to be motivated?

Could public opinion ultimately stop the executive pay spiral and put pressure on governments to take action to prevent pay excesses?  In the US, shareholders have been using new “say on pay” rules (where a firm’s shareholders have the right to vote on the remuneration of executives) to stage protest votes during this year’s annual meeting season. As a result, executive pay packages have been rejected in at least 39 companies, including Hewlett-Packard. The Dodd-Frank corporate governance reforms require companies to publish the ratio of the CEO’s pay to that of the median worker.  In Europe, the financial crisis and growing shareholder activism have helped to propel the issue up the agenda. “Say on pay” rules are spreading, as are disclosure requirements. Shareholders want to see clear company-specific linkages between strategy, risk and remuneration, rather than generic market-based comparisons. The public want to see the highest wage earners paying a fair rate of tax rather than finding extensive loopholes to avoid payment.

While salary levels are clearly important, most research evidence suggests that increasing monetary reward is not a major motivator in the long term. After all, why do wealthy people still continue work when they clearly have no financial need? This question could be explained using Maslow’s needs of self-esteem and self-actualisation, suggesting that employees have a need to fulfil their full potential through the intrinsic nature of their work, rather than through the level of their salary. Money may act as a short-term motivator, but it may also, cause conflict and difficulties between employees. In the long-run, it is usually more effective to motivate employees using non-monetary techniques.

Using money as the major motivator in business can lead to negative consequences for both employees and the business itself. If the business sets financial incentives based on quantity, using money as a motivator can harm the business, because quality may be sacrificed in a drive to increase production. If quality suffers, customers will be unlikely to purchase products or services from that business again.

Rewards that are based on individual employee performance may be a good way to use money as a motivator to increase productivity, but it may cause conflict between employees. This situation is worst when an employee’s contribution cannot be measured objectively when employees are doing the same job.

Despite problems that may occur from using money as a motivator, there are situations where it can be beneficial. If a business wants to reduce resistance to change, it could offer financial incentives including bonuses to those who will retrain or learn new systems, so implementing change more effectively. Monetary incentives may prove effective if a business needs to meet its short-term goals. Providing financial incentives would probably help create what Herzberg termed as a ‘movement’ or short term motivation. However, this additional motivation cannot be maintained indefinitely. It would be preferable for a business to motivate employees in non-financial ways, including empowerment by delegating responsibility and encouraging consultation to promote emotional commitment to the firm. This should allow employees to gain a sense of achievement and to satisfy high level needs in Maslow’s hierarchy, which is more likely to motivate employees in the long-term.

Returning to the case of executive pay, why should the arguments against using money as a motivator in the long-run be applied to the rank-and-file employee, but not to the firm’s chief executive? If ever high salaries are required to recruit and retain CEOs, why doesn’t this apply to all employees? Would lower remuneration packages lead to poorer performance and lower returns for shareholders, or would higher order intrinsic needs, such as self-esteem and self-actualisation be enough to ensure CEOs continue to work to their full potential?

IB-style questions

1. Define the following terms:

• Remuneration
• Wage differentials.

2. Distinguish between intrinsic and extrinsic needs and explain how these are classified by Maslow and Herzberg.

3. Analyse the advantages and disadvantages of placing restrictions on the remuneration packages of senior executives, such as those proposed by the Dodd-Frank corporate governance reforms.

4. Evaluate the impact of financial rewards on job satisfaction, motivation and productivity.

Class activity

Debate:

‘This house believes that top executive remuneration, such as the $378 million paid top executive is Apple Inc. chief executive Timothy Cook, is excessive and should be regulated.’