Rajika Jayatilake reports on how large unjustified bonuses corrupt top corporate executives in the US and elsewhere

High end earnings and bonuses are considered normal when associated with top-level corporate positions. As the saying goes, ‘a bonus is an award for audacity – salary is an award for modesty.’

However, high pay and massive bonuses are sometimes deemed unacceptable even in the most successful of corporate environments.

For instance, the shareholders of Starbucks Corporation in the US recently rejected the company’s executive compensation proposal in an unexpected reprimand of a Standard & Poor’s 500 (S&P 500) entity.

The compensation proposal for Starbucks executives that was rejected by its shareholders included a US$ 1.86 million one-time bonus and a larger retention payment for its CEO Kevin Johnson for fiscal year 2020. Starbucks’ proxy statement claims that the proposal’s aim was to retain Johnson as CEO through fiscal year 2022 as well.

Influential proxy advisory firm Glass Lewis recommended that Starbucks shareholders vote against the proposal, saying the business “paid (its CEO) moderately more than its peers but performed worse.”

As American steel magnate Charles M. Schwab once said: “I am not a believer in large salaries. I hold that every man should be paid for personal production.”

Yet, there have been instances when the concept of personal production has led to disastrous consequences. In 2016, America’s fourth largest bank – Wells Fargo – engaged in a strategy to grow its customer base by linking quotas for new accounts to bonuses to staff who brought in new clients.

This resulted in 3.5 million fraudulent new accounts on which the bank charged fees from real customers. When fined a hefty US$ 185 million, the bank changed its bonus programme in early 2017 and made bonuses a smaller share of staff pay. It also de-linked bonuses from sales and linked them to measurables such as customer satisfaction instead.

Then in February 2020, the bank agreed to pay three billion dollars to settle lengthy civil and criminal probes into the fraudulent accounts. Former CEO of Wells Fargo Timothy Sloan admitted: “We had an incentive plan in our retail banking group that drove inappropriate behaviour.”

Nevertheless, there is a clear trend of rising income inequality that’s been divorced from personal production in the US over the past four decades or so. It’s seen in the spiralling pay rates for top corporate executives.

CEOs of businesses have seen consistently rising pay over recent years – not be-cause of an increase in the value of their work but more as a result of their close ties with corporate board members who determine their pay levels.

Particularly in the United States, CEO earnings have clearly spiralled in an unjustifiable manner. For instance, the ratio of chief executive to typical worker pay has changed from 20 or 30 to one in the 1960s and ’70s, to 200 or 300 to one in recent years.

Moreover, a recent AFL-CIO labour federation analysis of new US federal data shows that CEOs of S&P 500 companies generally earn 287 times more than their average rank and file employees. The median annual pay of regular employees is US$ 39,888 while CEOs of Fortune 500 companies earn close to 20 million dollars annually.

If an enterprise enjoys a good year, CEOs are known to earn as much as 30-40 million dollars annually. Adding insult to injury, chief executives in America recently received a US$ 500,000 salary increase while the pay hikes of regular workers was barely over 1,000 dollars.

From another perspective, the financial crisis of 2007/08 was partly caused by large American businesses ignoring the long-term consequences of offering bonuses and other forms of immediate compensation to its executives.

Subsequently, in order to arrest the financial crisis, former US Representative and Chair of the House Financial Services Committee Barnett Frank, and former Senator Chris Dodd, cosponsored the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, which focussed on comprehensively reforming the US’ financial services industry.

It was signed into federal law by President Barack Obama on 21 July 2010.

Cautioned by the extent of the law’s reach, more businesses began paying attention to the potential consequences of excessive pay incentives for executives.

For instance, the Dodd-Frank Act included ‘Say on Pay’ as a mandatory nonbinding shareholder resolution offered by management, which allowed investors to approve a particular compensation package for specific executives such as CEOs, CFOs and three more highly compensated top officials.

As a result, the Say on Pay concept became a catalyst for shareholder protest.

The UK, feeling the heat of its own recent financial scandals – especially the 2018 collapse of Carillion –  is now seeking to join the US in finding the right balance of financial incentives for corporate executives.

Furthermore, the United Kingdom’s Secretary of State for Business, Energy and Industrial Strategy Kwasi Kwarteng has proposed regulations to “help get more transparency and frankly, honesty in the system.”

A Dutch proverb echoes this sentiment: ‘Honesty is the soul of business.’

I am not a believer in large salaries – I hold that every man should be paid for personal production

Charles M. Schwab
American steel magnate