Rewarding Failed and Unethical Managers

The following article is excerpted from a lecture by Prem Chopra at the University of Tennessee, Chattanooga in September 2006. The text of the entire lecture can be found in Masters of the Game: Reaching Beyond the Nexus to Success and Happiness.

Unjust Rewards – The Irony of Compensation for Failure

American business executives are well known for giving themselves positive rewards for negative actions. Take the example of some large public corporations. How are the Chief Executive Officers, or CEOs, compensated and rewarded? Well, they are paid salaries that are much higher, compared to the lowest-paid workers, than in any other developed or developing country. In addition, they are paid with company stock and stock options. In most business organizations there is a big discrepancy between the lowest-paid worker and the CEO. This is so all over the world. In approximate numbers, the ratio in Japan is about 1 to 115. In Europe it is about 1 to 150. In the US it is as high as 1 to 500, and in recent years it has continued to rise, creating an even bigger gap between the lowest-paid workers and executives.

Now, let me show you how rewards work in the opposite way, from which they should—how executives receive even more compensation for negative results. Here’s what happens, and it occurs repeatedly. When the corporation performs poorly, either due to poor management decisions or due to other reasons such as global unrest, the CEO lays-off or fires a large number of employees. Corporations have been known to fire tens of thousands of employees to reduce costs. However, the CEO continues to receive a salary and bonuses amounting to $10 million a year or more. Even $100 million is in compensation is not unheard of for some CEOs in a “good” year. In addition, they have options to buy stock at a fixed, generally below-market price. Some might earn as much hundreds of millions when they exercise those lucrative stock options, even if they are fired.

Now, here is the most interesting part of this reward system. Even if the CEO doesn’t get fired, once the corporation lays-off the people and reduces costs, thereby shoring up future earnings, the investment analysts, and investment bankers “talk up” the company. People start buying the stock and the price goes up, further enriching and rewarding the CEO who was responsible for the problems that led to the mass retrenchment and cutbacks in the first place.

Hewlett Packard provides an example of this. In the early 2000’s, after a spree of acquisitions and quality problems, they laid-off thousands of employees, but the price of their stock went up because they cut back several hundred million dollars in salaries and expenses. They closed plants, fired thousands of people and ruined families all around the world. Basically, such corporations run people into the ground and in return, the top executives and astute investors make millions of dollars because of quality problems. So even if the CEOs are fired, they make millions on their stock options. Such situations, which occur daily, are examples of inequitable and unethical reward systems in this country.

By contrast, in Japan for example, CEOs do not receive such unjust rewards. If a Japanese company gets into trouble, the top executive simply quits out of shame, and forgoing any compensation as a reward for failure. Sometimes Japanese executives even commit suicide.

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