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'The development of labor productivity and executive compensation on the backdrop of U.S. economy financialization'
Labor productivity is a key economic indicator, which is used to determine the effectiveness of employees’ work - the main productive force of industrial society. In an industrial society, increasing productivity serves as the principal means not only for economic growth, but also for improving the living standards of citizens. With the growth of labor productivity becomes an increase in wages and other income. Important feature of this process is a higher rate of productivity growth compared with the rate of increase in wages and workers' real earnings.
However, such a relationship between the rate of growth of labor productivity and wages are not always performed, even in an industrial society. On the one hand, there is a wage restraint in order to increase the profits of entrepreneurs, and the other - its rapid growth in the case of incentives for accelerated productivity growth. Both options have taken place in the history of modern national economies.
Productivity depends on the type of technical, technological and social development. In the previous century in the developed countries, a transition from industrial to post-industrial development and therefore productivity in the new sectors of the economy related to finance, innovation, creativity.
In a recent type of industrial development, which was replaced by a new type of post-industrial development in most countries in the mid-1980s, there was a systematic increase in productivity, especially in industry (Table 1).
Data in Table 1 indicates that a particularly high increase in labor productivity was observed in the Netherlands (from 3.1 to 7.4%) and Belgium (from 4.6 to 6.9%). The rates of growth of labor productivity in the United States were lower than the average growth in the European countries. At high rates of GDP growth it pointed to the fact that for the US, which first embarked on the development of post-industrial economy, this indicator has ceased to play the significant role he played in the industrial economy. The old production function was replaced by a new performance measure for post-industrial economy - the growth of value added.
At the same time there was a process of significant growth in non-industrial sectors, such as services (trade, finance, advertising, etc.), where there was a significant increase in profitability than in industry and hence productivity, if it has to measure the growth of surplus product, and not increase in gross domestic product.
Levels of executive pay were not a particularly debated issue in the decades following the end of the Second World War. Not only were labor markets subject to limited degrees of internationalization, but sectors in which high levels of executive compensation would later emerge, such as the financial sector, were not expanded to the same degree as they would become in future decades. Levels of income tax in capitalist countries were also historically high. In the United States, the standard bearer of global capitalism in the postwar years, the top rate of income tax was 91% between 1946 and 1963 (Prosser, 2009).
The rise of globalization in the 1990s also made the topic of executive compensation a greatly more debated one. The internationalization of labor markets led to the ‘war for talent’ in many sectors and this had an inflationary effect upon levels of executive compensation. The growing prestige of the Anglo-Saxon mode of corporate governance also led to a growing emphasis on ‘short-termism’ in compensation schemes and the rise of bonus payments. Regulatory approaches to executive compensation also became more liberal. Rates of income tax continued to fall as globalization intensified competition between national tax regimes. Between 2003 and 2008 the average top rate of income tax in the world’s most developed economies fell from 31.3% to 28.8% (KPMG, 2008)
In the years just prior to the outbreak of the economic crisis in 2007, levels of executive compensation had reached historic levels. In addition to base salaries, executive compensation packages typically came to include bonuses, stock awards, options and pension arrangements. Total remuneration for executives commonly started to top $1 million a year. The phenomenon of multi-year guaranteed annual bonuses, where executives were guaranteed bonuses irrespective of performance, also became widespread. According to a study conducted by the U.S. Economic Policy Institute (Table 2), in 2003 the average rate of Chief Executive Officer (CEO) pay in the United States was $2,249,080.
The development of ‘say on pay’ policies on executive pay have been popular in many national contexts since the start of the crisis. ‘Say on pay’ policies involve giving shareholders within firms the right to vote on compensation levels of executives. There are several examples of such policies in the United States. In 2008, the Emergency Economic Stabilization Act was passed that established the Troubled Assets Relief Programme (TARP) that allocated funds to firms in financial difficulty. As part of the Act, firms that owed money to the TARP were legally required to hold ‘say on pay’ resolutions. Throughout 2009, the U.S. public authorities signalled their determination to uphold this requirement in firms that had received funds from TARP. The use of ‘say on pay’ policies in the U.S. developed further. In July 2009, the U.S. House of Representatives passed the ‘Corporate and Financial Institution Compensation Fairness Act of 2009’. This bill allowed for ‘say on pay’ resolutions at all public institutions within the U.S., and also provided shareholders with the right to vote on ‘golden parachutes’ (an agreement on benefits for executives in the event of termination of employment) for executives (Ebert, Torres & Papadakis, 2008).
The presence of institutional investors has been identified as having an influence on executive compensation. A study by Hartzell and Starks (2002) covering a large number of firms in the United States in the period 1991-1997 finds that the level of executive compensation decreases anti-proportionally to the concentration of institutional investors: the higher the number of institutional investors, the lower the compensation of executives, and vice versa (Hartzell and Starks, 2002).
Parthiban, Kochar and Levitas (1998) distinguish between institutional investors with and without other business relationships with the firm. They find that the level of executive compensation is positively related with the former (i.e., in the presence of additional relationships between the institutional investors and the firm) and negatively with the latter (in the absence of such relationships). Comparable findings are reported in the case of the UK (Parthiban, Kochar and Levitas, 1998).
The role of share-based compensation has been widely disputed in recent years. Criticism has in particular been uttered with regard to the traditional design of stock options. Stock options plans allow executives to benefit from increases of stock value regardless of whether the positive development of the stock price is linked to the performance of the firm or with growth the industry concerned or the country economy as a whole. As a consequence, executives may often benefit from stock option programmes although the performance of their firm – and thus their own performance – is poor which deprives the stock option plans of their incentive and reward effect (Bebchuk and Fried, 2004).
Academics have therefore put forward more sophisticated stock option plans which include a comparison of firm performance with the average of a peer group or other additional performance criteria. Another problem relates to the practice of stock options re-pricing. This re-pricing normally occurs if stock options turn out to not to be as lucrative for the holders (CEOs, executives) as expected because of an unfavorable evolution of shares value. In this regard Carter et al. (2003) highlighted that numerous companies decided to re-price their stock options, not only in the event of poor performance of the industry in which the company operates (let alone the economy of the country) but even –and indeed mainly- in the event of poor firm performance. These developments lead, among other things, to a clear distortion of the incentive effect of stock options. Some academics go further, contesting the added-value of share-based compensation as a whole, arguing that monetary incentives are inefficient to stimulate executives’ behavior in the interest of shareholders as they would hamper or “crowd out” the intrinsic motivation of executives (Ebert, Torres & Papadakis, 2008).
A number of proposals deal with the institutional framework in which executive compensation is determined. Some of those proposals argue for an enhanced role of the shareholder meeting, usually referred to as “Say on Pay”. The focus of the debate in the United States is current on a non-binding vote of share-holders on executive compensation matters. While not providing shareholders with a veto on compensation packages, shareholders would have an institutionalized platform to express their disagreement with the remuneration policy of their company (Gopalan, 2007).
Similarly, a recent proposal of the Austrian trade unions argues for the strengthening of information rights of the shareholders on executive compensation matters. Other proposals favor an enhancement of the committee in charge of determination of compensation. For instance, German trade unions argue for a stronger role of the German supervisory board and in particular for a more intensive participation of the employee representatives in the compensation determination process. Certain proposals also deal with the amount and the criteria employed to fix executive compensation. Proposals from German and Austrian trade unions suggest that, when determining executive compensation, not only personal performance and firm performance but also other criteria such as social and environmental sustainability should be taken into account. A third group of proposals deals with a more rigid taxation of executive compensation. It is suggested that companies should no longer be able to deduct executive compensation as a business expense. According to these proposals, this would set a negative incentive for excessively high executive compensation by increasing the compensation costs of the company. Proposals along those lines have been put forward, among other, in the US (Ebert, Torres & Papadakis, 2008).
The present paper has tried to highlight certain cross-national tendencies regarding the institutional framework, structure and recent major trends in the field of executive compensation. It has become obvious that executive compensation differs considerably across countries, from the viewpoint of determination, disclosure, constitutive elements, and levels.
The research strand dealing with international executive compensation has emerged only recently and therefore requires further elaboration. A more systematic international comparison of share-based compensation and on the use of pension systems and termination benefits need to be further developed. Another field of research which merits more attention has to do with the redefinition of the very concept of CEO performance in a way that focuses not only on the economic dimensions of performance, but also on social and environmental ones. Last but not least, research regarding ways to improve executive compensation will remain an interesting topic and a cornerstone in the area of corporate governance as a whole.
Michael H. Mescon (1988), Michael Albert, Franklin Khedouri ‘Management’, .
KPMG, 2008: ‘KPMG’s Individual Income Tax Rate Survey 2008’.
Thomas Prosser (2009) ‘Executive compensation and the economic crisis’,.
Bebchuk, L. A., & Fried, J. M. (2004) ‘Pay Without Performance: The Unfulfilled Promise of Executive Compensation’.
Gopalan, S.(2007) ‘Say on Pay, and the SEC Disclosure Rules: Expressive Law and CEO Compensation, Pepperdine Law Review’.
Franz Christian Ebert, Raymond Torres, Konstantinos Papadakis (2008) ‘Executive compensation: Trends and policy issues’.
Parthiban D., Kochar R. and Levitas E.(1998) ‘The Effect of Institutional Investors on the Level and Mix of CEO Compensation’.
Dong M., Ozkan A. (2007) ‘Institutional investors and director pay – An empirical study of UK Companies’.
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