From the Top: Examining CEO Compensation

The numbers seem unreal: $253 million to the CEO of a private equity firm, $226 million to the CEO of a major tech company, and $168 million to the CEO of a leading fitness brand. These figures aren’t for a lifetime or a career's worth of service; they are salaries for one year of work.

Blue- and white-collar employees alike have taken notice. Over the summer, members of the Writers Guild of America and the Screen Actors Guild went out on strike, shutting down all of the major Hollywood movie studios and the television industry, demanding higher wages, and criticizing the exorbitant packages enjoyed by executives at most of the studios.

This was followed in September by a strike by the United Auto Workers against the major American automakers, citing among their grievances the drastic difference between the pay of the average worker and the compensation received by the CEOs of all three companies. According to a recent Gallup poll, nearly two-thirds of Americans approve of labor unions, with support for unions having shown steady growth over the past decade.

Executive compensation has exploded in recent decades as companies have sought to retain top talent while driving shareholder value. The Economic Policy Institute estimates that the ratio of CEO pay to the wages of average workers in their company jumped from roughly 20-to-1 in 1965 to about 399-to-1 in 2021. The ratio began expanding suddenly in the late 1990s when stock-based (or incentive-based) compensation became popular.

Layla Silver (C) pickets as striking SAG-AFTRA members picket with striking WGA (Writers Guild of America) members outside Paramount Studios on September 18, 2023 in Los Angeles, California. (Photo by Mario Tama/Getty Images)

Layla Silver (C) pickets as striking SAG-AFTRA members picket with striking WGA (Writers Guild of America) members outside Paramount Studios on September 18, 2023 in Los Angeles, California. (Photo by Mario Tama/Getty Images)

Workers picket outside of the Ford Assembly plant as the UAW strike against the Big Three U.S. automakers continues on October 10, 2023 in Chicago, Illinois. The strike, which started on Sept. 15 at three locations, has now been expanded to 43 facilities nationwide. (Photo by Scott Olson/Getty Images)

Workers picket outside of the Ford Assembly plant as the UAW strike against the Big Three U.S. automakers continues on October 10, 2023 in Chicago, Illinois. The strike, which started on Sept. 15 at three locations, has now been expanded to 43 facilities nationwide. (Photo by Scott Olson/Getty Images)

Rong Ma, associate professor Rutgers School of Business–Camden

Rong Ma, associate professor Rutgers School of Business–Camden

Rong Ma, an associate professor in the School of Business at Rutgers University in Camden, recently published an article with several co-authors examining how the size and structure of a CEO’s compensation package can influence their willingness to take risks that result in significant economic ripple effects.

“If approached correctly, incentive-based executive compensation helps align the interests of leadership with those of the company and the stockholders,” Ma said. “But if corporations fail to understand how their CEOs will respond to incentives, the opposite can be true.”

Understanding this connection is critical for two reasons: It advances the larger discussion on executive compensation in an age of ever-expanding CEO salaries, and it can help companies understand whether their compensation packages support the organization’s priorities and goals. In other words, are companies and shareholders getting what they pay for from executive leadership?

Executive compensation is often a diversified offering of cash, benefits, and stock designed to motivate decision-making and performance. At their peak in 2001, stock options, which offer recipients the choice of whether or not to purchase stock at a given price, accounted for more than 50% of executive pay at most major U.S. companies, while restricted stock, which differs from stock options in that it is a direct gift of stock that cannot be sold for a defined period, has become more prevalent in recent years.

“If approached correctly, incentive-based executive compensation helps align the interests of leadership with those of the company and the stockholders.”
Rong Ma

Ma was curious whether restricted stock grants could change an executive’s willingness to take risks when making critical decisions. She suspected that restricted stock would cause executives to respond differently to risk depending on their “regulatory focus,” a psychological term that describes how individuals evaluate and pursue the goals set before them.

Ma hypothesized that individuals with a “promotion-focused approach”—in other words, CEOs motivated by achievement and growth—would have a higher tolerance for risk-taking when given restricted stock as part of their compensation. Comparatively, CEOs with a “prevention-focused approach”—those motivated by caution and vigilance—would gravitate toward more conservative decisions when given restricted stock.

“Most of the previous literature focuses on stock options, which offer the opportunity but not the obligation to purchase stock at a set price by a certain date,” said Ma. “While considerable evidence shows that stock options motivate executives to adopt longer time horizons and accept greater risk, it has also been found that stock options tend to lead CEOs to make larger bets, which can produce either big wins or big losses.” She emphasized that experiences, values, and personalities shape an executive’s interpretations of strategic challenges. As a result, CEOs are likely to respond to the same incentives differently depending on their perceptions and psychological characteristics.

“While considerable evidence shows that stock options motivate executives to adopt longer time horizons and accept greater risk, it has also been found that stock options tend to lead CEOs to make larger bets, which can produce either big wins or big losses.”
Rong Ma

Ma conducted a comprehensive review and analysis of 490 companies from the Standard and Poor’s 500 over a 13-year period, as well as a review of previous research on company letters to shareholders found in annual reports and publicly available financial information. To determine regulatory focus, she completed a content analysis of CEO letters to shareholders, which researchers have found to be a reliable indicator of executive perspective. The results confirmed her suspicions: Restricted stock grants resulted in a higher level of risk-taking for promotion-focused CEOs and lowered risk-taking for prevention-focused CEOs.

“Our findings show that loss aversion, something companies may want to a certain degree in a CEO, may not be a universal attitude because regulatory focus plays a role when it comes to an individual’s choices regarding risk,” Ma said.

Ma emphasized that because the effect of restricted stock on risk-taking varies across CEOs, organizations may only achieve their goals by gaining a better understanding of an individual CEO’s outlook.

“Incorporating CEO regulatory focus into hiring decisions may allow companies to achieve their strategic goals more effectively by maximizing compensation effectiveness,” Ma said. “Companies may need to adopt a more holistic approach and design more customized compensation packages that reflect an executive’s appetite for risk to maximize the effectiveness of their CEO’s equity-based compensation. This knowledge may allow CEOs to assess their own decisions more clearly, which should result in more effective and appropriate strategic planning overall.”

It’s research that truly gives new meaning to the age-old adage: “Know thyself.” However, it remains to be seen whether that will be enough for the average worker—like those who walked the picket lines this summer and fall—especially if the ratio between executive compensation and an average wage doesn’t become more aligned over time.

Design: Douglas Shelton