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3. Managerial Rewards and Incentives
From a corporate governance perspective, one of the most critical roles of the board of
directors is to create incentives that align the interests of the CEO and top executives with the
However, CEO pay appears to be somewhat out of control, with CEO pay escalating over
time and with the average CEO pay in S&P 500 firms being 330 times the pay of an average
Extra Example: Copy Cat Compensation Policies Lead to Pay Inflation
David Larcker, who directs Stanford University’s corporate governance program, says companies can measure
performance one of three ways: by stock price gains (with or without dividends added), by accounting measures
(like profit gains) and by non-financial indexes like customer satisfaction and employee turnover. “A company ought
to pick performance indicators for bonus schemes that are consistent with its corporate strategy,” Larcker says.
Although corporate governance pundits have been parroting such truisms for years, there is little evidence that major
corporations actually use such guidelines. Rather than pay for performance, 86 percent of S&P 500 companies
consider what groups of peer corporations pay their bosses. GM’s board was not dissuaded merely by a plunging
stock price from paying Wagoner millions and instead based his pay in part on how much IBM, Altria and other,
mostly more successful, firms paid their bosses.
The result is a Lake Wobegon effect: everyone struggling to be paid above average. The result of peer comparisons
is that chief executive pay grew from 40 times average worker pay in 1980 to 330 times in 2013. Finally the recent
recession took pay down, but only a little. Median pay in 2008 fell 10 percent from the year before among 148 large
corporations, but this drop was a lot less than the 37 percent drop in stock prices (and shareholder wealth) for firms
in the S&P 500.
Source: Lambert, E. 2009. The right way to pay. Forbes, May 11: 78–80.
Discussion Question 38: It could be argued that since top corporations have to compete
for top talent, it is okay to, in essence, “out-bid” the competition by offering larger
compensation packages to attract the best talent. Do you agree? Why or why not?
There must be an effective combination of three basic policies to create the right financial
incentives for CEOs to maximize the value of their companies:
1. Boards can require that the CEOs become substantial owners of company stock.
2. Salaries, bonuses, and stock options can be structured so as to provide rewards for
The SUPPLEMENT below points out that executive compensation, which is supposed to
align the interests of stockholders and managers, can lead to managers to pay too much attention
to short-term performance.
Extra Example: Bonuses and Stock Grants Can Lead to a Short-Term Focus
Commentators regularly lament the short-term focus of managers of corporations. This problem is often attributed to
activist investors pushing for quick performance improvements and day traders punishing firms for momentary
missteps, but the empirical evidence indicates that activist investors have a longer-term focus and that day traders
have little influence on the strategic actions of firms.
So, what leads managers to take such a short-term focus? It may be the structure of top managers’ compensation.
Firms often grant top executives’ bonuses based on a single years’ performance. With this timeframe, it is not
surprising that top executives manage the firm to perform well in the short term. Options they grant typically vest in
three years and are instantly exercisable by managers. Thus, managers have an incentive to goose up the firm’s stock
price as much as possible right around the options’ vesting date, at which point they quickly cash out.
What are possible solutions? It may be as simple as using three- to five-year windows of performance for bonuses.
Additionally, rather than allowing managers to immediately cash out their options, firms could require managers to
hold a proportion of their vested stock options for an additional three to five years before selling them to generate a
longer-term perspective.
Source: Pozen, R. 2014. The Misdirected War on Corporate Short-Termism. wsj.com. May 19: np.
We address some figures on the tremendous pay packages that top executives of publicly-
owned corporations have earned in recent years.
Teaching Tip: You can spur a lot of debate by asking if the amount of executive pay in
recent years has become excessive. Some students will claim that it helps to attract top
talent and that, if tied to corporate performance, any level is justified. Others may feel
Much of the wealth that CEOs and other top executives have created for themselves is
Discussion Question 39: What resistance do you foresee to the implementation of some
of the actions recommended in this exhibit?
Discussion Question 40: Would requiring executives to invest a year’s salary in the
company turn away potentially good candidates, and thus limit the company’s options for
top leaders?
C. CEO Duality: Is it Good or Bad?
Duality, where one person is both CEO and Chairman of the Board of Directors, is one of
There has been a great deal of pressure to separate these roles, and a number of firms did
so in response to pressure they received in recent years. We discuss research suggesting that the
Discussion Question 41: Under what conditions is duality advisable? Why?
D. External Governance Control Mechanisms
Thus far, our discussion has been on internal governance mechanisms. However, internal
controls do not always ensure good governance. The separation of ownership and control that is
1. The Market for Corporate Control
If a company’s internal control mechanisms are failing—that is, the board is not
effectively monitoring managers and shareholders are largely indifferent, there is a strong
likelihood that managers will behave opportunistically. Such behavior can take many forms,
The market for corporate control is one external mechanism that provides a potential
solution to the problems above. Rather than “fight,” shareholders will eventually sell their shares,
The first thing a “successful” corporate raider may do upon gaining control of the
corporation is to fire the management and replace it with its own appointed leaders. The risk of
In recent years, the threat of the takeover constraint has become less effective as the
2. Auditors
Despite stringent disclosure requirements, there is no guarantee that the information
disclosed by a firm will be accurate. Managers may purposely disclose false information or
However, these audits often fail to catch accounting problems. A recent study found that
big accounting firms were deficient in their audits of 20 to 45 percent of audits they conducted.
3. Banks and Analysts
Financial institutions and stock analysts are two external groups that monitor publicly-
held firms. Commercial and investment banks have a vested interest because they lend money to
In practice, analyst recommendations have been more optimistic than warranted by the
facts. “Sell” recommendations are very infrequent, in part, because most analysts work for firms
4. Regulatory Bodies
All corporations are subject to some regulation by the government and the extent of
regulation is largely a function of the industry within which they compete. Industries such as
banks, utilities, and pharmaceuticals are subject to more regulatory oversight because of their
The failure of a variety of external control mechanisms led the U.S. Congress to pass the
Sarbanes-Oxley Act in 2002. This act calls for stringent measures to ensure better governance of
Although the financial regulation of corporations by the Securities and Exchange
Commission and the Internal Revenue Service are often the most visible government regulators,
Extra Example: The NLRB Takes on Boeing’s Expansion
For years, Boeing has had a contentious relationship with unions at its main production facilities in the state of
Washington. When Boeing faced growing demand for its planes, and it needed to expand its operations, it decided to
open a new plant in South Carolina. Boeing hoped it would have better relationships with workers in North
Carolina, which tends to have weaker unions and more favorable labor rates than Washington.
Even though Boeing did not plan to cut any jobs to its unionized workforce in Washington, the National Labor
Relations Board (NLRB), the federal agency that regulates labor and union rules, charged Boeing with retaliating
against its unionized workers in Washington by opening the new plant in South Carolina. The NLRB threatened to
block the opening of the South Carolina plant. The NLRB pressed its case for months, but it dropped the case after
the International Association of Machinists (IAM), the main union in its Washington plants, asked the NLRB to drop
the case. Why did the union ask the NLRB to drop the case? It only did so after Boeing guaranteed that a new plane,
the 737 Max, would be manufactured in Washington and offered the unionized workers raises and bonuses.
Critics have looked at this deal and concluded that the NLRB acted not as an independent, neutral regulator but,
instead, as an agent for the IAM, insuring that the union was able to squeeze Boeing to offer it a sweetened union
contract. Others have argued that the NLRB was only acting to ensure that Boeing didn’t harm its unionized workers
in Washington by moving production to South Carolina.
Source: Anonymous. 2011. Boeing bullied. The Economist. December 17: 115.
Such a highly partisan perspective should generate some spirited discussion. Ask:
Discussion Question 42: Do you think the NLRB acted fairly in this case?
Discussion Question 43: How should Boeing have handled this situation?
5. Media and Public Activists
Although the press is not typically recognized as an external control mechanism in the
corporate governance literature, it would be hard not to argue that the financial press and media
play an important role in monitoring the management of public corporations. In the United
Consumer groups and activists can also play a very visible role by crusading against what
they perceive as corporate malfeasance. We briefly describe a few of Ralph Nader’s 30 watchdog
Discussion Question 44: Do you feel that Ralph Nader’s groups constitute an effective
external governance mechanism for corporations? Why? Why not?
The SUPPLEMENT below points out how a CEO can be viewed by outsiders, depending
Extra Example: CEO Friend or Foe to the Environment?
Cypress Semiconductor CEO T.J. Rodgers certainly would qualify as a black hat to many. No friend of
environmentalists and others who disagree with his libertarian reflexes, Rodgers is as outspoken as he is blunt. For
example, Rodgers was seated between representatives from Environmental Defense and the Competitive Enterprise
Institute at a 2008 panel discussion on climate change. Likening their remarks to “two loudspeakers screaming
political slogans,” he said, in his typical manner, that he “almost would rather have been waterboarded.”
In 1996, Rodgers first gained a degree of notoriety with the socially and environmentally oriented community when
he replied to a letter from Sister Doris Gormley, a Philadelphia nun. Sister Doris expressed disappointment in the
makeup of Cypress’s board of directors, which included no women or minority members. “Get down from your high
horse,” Rodgers urged in his blistering 2,800-word letter of refutation, labeling Sister Doris’s requirements
“immoral.” He argued that he would be happy to add a woman or minority to his board—so long as they brought the
requisite talent for the job. Lost in the biting tone of the letter were the great many positives at Cypress identified by
Rodgers, from premium salaries to excellent benefits to an award-winning charity program. The letter was quickly
publicized, leading to charges that Rodgers had stooped to “nun-bashing.”
Given the ill will that this episode left behind, it is ironic that Rodgers’s SunPower is now busy manufacturing solar
cells that reduce carbon emissions and support energy independence. In the days of cheap oil, SunPower was down
to its last watt when Rodgers joined and invested in the company. His investment was part of the solution that kept
the operations going trough the thin years, until demand picked up for the company’s improving solar cells.
Source: Russo, M.V. 2010. Companies on a mission. Entrepreneurial strategies for growing sustainably,
responsibly, and profitably. Stanford, California: Stanford University Press.
Discussion Question 45: Should we celebrate T.J. Rodgers’s solar energy success story
or second-guess his business methods? Should the focus be on the CEOs’ results or on
the way they achieve them?
E. Corporate Governance: An International Perspective
In this section, we recognize that corporate governance differs among countries and
regions of the world. In the United States and the United Kingdom, corporate governance has
Such a perspective, however, seldom applies outside of the United States and United
Kingdom. This is particularly true in emerging economies and continental Europe where there is
often:
concentrated ownership
extensive family ownership and control
Thus, serious conflicts often exist between two classes of shareholders: controlling shareholders
EXHIBITS 9.8 and 9.9 address how principal-principal conflicts differ.
There must be three conditions for PP conflicts to occur. These are:
a dominant owner or group of owners who have interests that are distinct from the
a motivation for the controlling shareholders to exercise their dominant positions to
few formal (i.e., legislation or regulatory bodies) or informal constraints that
The result is that family managers, who represent (or actually are) the controlling shareholders,
Another ubiquitous feature of corporate life outside the United States and Great Britain
are business groups such as the keiretsus of Japan and the chaebols of South Korea. These are
particularly dominant in emerging economies. A business group is “a set of firms which, though
legally independent, are bound together by a constellation of formal and informal ties and are
The SUPPLEMENT below addresses an interesting issue: Is there a global standard for
governance?
Extra Example: Is There a Global Standard for Governance?
Various ownership structures, financial market infrastructures, cultural influences, and legal systems create
alternative approaches to corporate governance structures and philosophies in countries around the world. For
example, the governance systems that exist in such markets as the United States, Germany, Japan, China and Russia
are all distinctive and reflect their own political and market economies. The United States is characterized by
dispersed ownership structures, a strong shareholder orientation, and a tradition of “outsider” governance through
independent non-executive directors. Japan and Germany are more stakeholder oriented, have a higher concentration
of ownership and corporate control, and a tradition of “insider” governance involving controlling shareholders as
well as banks or related industrial groups. Russia and China, on the other hand, are undergoing a transition to more
market-oriented economies, and have an insider/outsider mix.
Will such distinctions prevail or will a global governance standard emerge? There is no one country model that has
proven to be ideal; all systems are vulnerable to problems. These include conflicts of interest with controlling
shareholders, ownership rights, stakeholder relations, problems of control and risk management, effectiveness and
independence of board oversight and excessive executive compensation.
In particular, ownership structure can be a key differentiator. The governance concerns of a widely-held firm can be
quite different compared to those with concentrated ownership. Thus, many of the governance practices advocated
in American might fit poorly for closely-held firms in Europe or Asia. However, this does not mean that European or
Asian companies should be passive or complacent. After all, family-owned firms around the world generally benefit
from protecting minority shareholder rights, disclosing relevant financial and non-financial information, and having
a meaningful level of independent board oversight.
What should companies do?
consider governance to be both a source of competitive advantage and a key aspect of enterprise risk
management
regularly review governance structures and practices—particularly for publicly-traded companies wanting to
maintain access to public capital markets
strive to improve transparency and disclosure standards—especially with regard to non-financial risks and
how these are communicated to various stakeholder group
Source: Dallas, G. 2005. Ensuring companies walk the talk. www.euromoneyplc.com, np.
Discussion Question 46: What are the pros and cons of establishing global standards of
governance? Is it a goal worth striving for?
IIV. Issue for Debate
How students respond to this case may be driven by their underlying values. Some
students, who consider CEO pay to be egregiously high, may focus on the inequity and
Discussion Question 47: Is it appropriate for firms to insulate their CEOs pay from bad
luck?
The instructor may wish to poll the class to see if there is a dominant view. If there is, the
instructor may wish to ask someone to express this view and then question the class to get
The key point is that there is no objectively correct answer. However, the viewpoints
expressed typically reflect an individual’s values and views on corporations. Some may argue
The instructor may wish to push the discussion to when and under what conditions it is
appropriate to insulate CEOs from bad luck. Drawing on agency theory arguments, you may
Discussion Question 48: How can firms restructure pay to ensure that the CEOs also don’t
benefit from good luck?
To make the process seem equitable, it would seem that the CEO should not benefit from
good luck if she is going to be insulated from bad luck. One way to do this is to only offer the
V. Reflecting on Career Implications
Below, we provide some suggestions on how you can lead the discussion on the career
implications for the material in Chapter 9.
Behavioral Control: What types of behavioral control does your organization employ?
Do you find that these behavioral controls help you to do a good job or hinder you from
doing a good job? Some individuals are comfortable with and even desire rules and
Students should understand that at work there is a culture. It determines acceptable dress and
behavior. Ask students for examples of behaviors are not acceptable at their work, but which may
be acceptable in other places. Now ask how the organization enforces these norms. Usually
students will appreciate the subtle and nuanced way that organizational norms are enforced
Setting Boundaries and Constraints: Your career success depends to a great extent on
you monitoring and regulating your own behavior. Setting boundaries and constraints on
yourself can help you focus on strategic priorities, generate short-term objectives and
Personal boundaries are important for students to consider, especially when it comes to ethical
behavior. Ethical behavior directly applies to the business environment, too. Ask students what
ethical behavior they could not ever consider, regardless of the financial reward, such as
Rewards and Incentives: Is your organization’s reward structure fair and equitable? On
what criteria do you base your conclusions? How does the firm define outstanding
performance and reward it? Are these financial or nonfinancial rewards? The absence of
Students can benefit from examination of their organization’s reward structure. One way to look
at rewards is as a form of positive feedback that encourages a firm’s desired behavior. Feedback
can be pecuniary, such as salary, raises, and other compensation; or non-pecuniary, such as
“employee of the month” awards or other recognition. Ask students to list the types of rewards
Culture: Given your career goals, what type of organizational culture would provide the
best work environment? How does your organization’s culture deviate from this concept?
Does your organization have a strong and effective culture? In the long run, how likely
This topic is a continuation of the first one. It personalizes students’ responses to organizational
culture in the long term. In reality, many students will not know the extent to which they can
adapt to an organizational culture, so the goal is not to have them assess whether or not they can
survive in a specific organizational culture. A possible fruitful approach is to have students list
