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Exorbitant CEO compensation: just reward or grand theft?

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Abstract

The failure of society to criminalize policies and practices of powerful organizations and individuals that are demonstrably harmful has been a central theme of the white collar crime literature since Sutherland. In recent years much commentary and criticism has been directed at vastly exorbitant compensation packages awarded to CEOs of major corporations and other major institutions. Although some criminal prosecutions have been pursued on the basis of allegations of fraud in relation to CEO compensation (e.g., the Dennis Kozlowski/Tyco case and the Conrad Black/Hollinger case), and some civil lawsuits demanding repayment of unjustifiably large CEO compensation have been initiated (e.g., the Richard Grasso/New York Stock Exchange case), most typically exorbitant CEO compensation packages result in neither criminal indictments nor civil lawsuits. This article explores the status of exorbitant CEO compensation as a criminological phenomenon, beginning with a typology of different views on such compensation. The contemporary scope of disproportionate compensation is reviewed, with the exponential increase in the gaps between the compensation of CEOs and those below them documented. Some of the different mechanisms along a continuum of legal to illegal for providing exorbitant CEO compensation are identified. Why is the awarding of exorbitant CEO compensation typically legal? What specific forms of harm arise from awarding exorbitant CEO compensation? Why do Corporate Board Compensation Committees award exorbitant CEO compensation? Indeed, what are the specifically criminogenic dimensions of Corporate Board decision-making that contribute to this process? What arguments can be advanced in favor of criminalizing exorbitant CEO compensation and against doing so? What specific practical constraints would have to be overcome to criminalize the awarding of exorbitant CEO compensation? If exorbitant CEO compensation has not been addressed traditionally as a form of white collar crime, what arguments can be advanced in favor and against doing so now? This article promotes attention to the exorbitant CEO compensation issue by white collar crime scholars, with a provisional addressing of the questions raised above.

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Notes

  1. Are concerns about extravagant CEO compensation best understood in terms of envy, or jealousy? Law professor Jeanne L. Schroeder, within the context of a discussion of the Martha Stewart insider trading case, brings in the concepts of envy and jealousy. Envy is characterized “as the pain one feels in seeing another experience joy. Envy is the mirror image of schadenfreude—the joy one feels in seeing another experience pain” [95: 301]. Schroeder also claims that envy and jealousy are ethically distinct. With jealousy one wants to claim possession and protect what one believes one is entitled to, whereas with envy—one of the deadly sins—one wants to destroy the enjoyment of another whether or not it is rightful [95: 302]. Indisputably there is a significant element of public schadenfreude when some of the CEOs viewed as exorbitantly compensated get into trouble, and in the extreme case go to prison. This was true of Martha Stewart, as well as Jeffrey Skilling, Bernard Ebbers and Dennis Kozlowski. And envy of the super-rich—rich by whatever means—is clearly widely diffused in a profoundly materialistic culture such as ours. But it is central to the argument being advanced here that the core objection to exorbitant CEO compensation is, if anything, driven by jealousy in the sense that these CEOs are being awarded resources that in large measure rightly belong to other stakeholders, including shareholders, corporate employees, and consumers.

  2. Gilbert Geis [36: 49] is unsurprisingly a rare exception to this proposition. He notes that the “obscene” compensation today awarded to some CEOs may be legal, but has a generic relationship to white-collar crime when executives feel pressured to misrepresent their business’s earnings to justify their exorbitant compensation, or to make the case for exorbitant compensation.

  3. See Friedrichs [34] for a typology of white collar crime incorporating such hybrid types.

  4. David Brooks, the CEO of DHB Industries, earned hundreds of millions of dollars and allegedly threw a US$10 million party for his daughter, during a period when 18,000 of the bulletproof vests his company sold to the U.S. military for use in Iraq were recalled as defective! [75].

  5. The phenomenon of exorbitant CEO pay has not been restricted to CEOs heading large corporations, but has spread to other realms including semi-public entities or non-profit entities such as stock exchanges, museum institutions, and universities. Richard A. Grasso, who began his career with the New York Stock Exchange as a floor clerk (without a college education) and became chair of the exchange, in his final years was being compensated over US$30 million a year (including deferred gratification) for leading this semi-regulatory entity [35]. His successor as chair of the exchange was paid a seventh as much, or US$4 million a year [94]. Grasso was forced out in the wake of the uproar following disclosure that he received almost US$140 million as a pay-off of accrued pension and retirement savings [105]. A New York State lawsuit demanding return of much of this money was premised on the notion that it exceeded a standard of “reasonableness” for “not-for-profit” entities, and was obtained by deception [105].

    Lawrence M. Small, the top official at the Smithsonian Institution until pressured to resign in 2006, had a final compensation package of close to US$1 million a year, took ten weeks a year of vacation, spent 64 days in lucrative corporate board service, and exploited a lavish spending account [88].

    E. Gordon Gee as president of Vanderbilt University earned US$1.2 million a year, or 75 times as much as the university’s ground workers [106, 12/4/06]. This level of compensation reflected a trend toward dramatic increases in pay for university heads and high-level administrators.

    Many other examples of extravagant or exorbitant CEO compensation in a range of private and public institutions could be cited.

  6. The traditional rationale for the lower capital gains tax rate is that it encourages and compensates for enterprising and risky investment that is beneficial to the economy as a whole. But New York Times columnist Paul Krugman [52], a highly-regarded economist, points out that equity fund managers are not putting their own money at risk in managing the money of other people, so the rationale of encouraging investors to put their money at risk in entrepreneurial investments simply does not apply. The minor political firestorm that arose in response to media reports on the foregoing resulted in several of the democratic presidential candidates—i.e., Hillary Clinton, Barack Obama and John Edwards—coming out in favor of raising the tax rate on this form of fund manager income, along with a proposed Senate bill along these lines.

  7. In both Europe and Asia, trends are moving somewhat in the direction of extravagant American CEO compensation practices, although this has inspired some significant negative reaction. In any cases, the significant disparities noted here persist.

  8. In addition to CEOs, the primary beneficiaries of mergers and buyouts tend to be investment bankers and corporate lawyers, not ordinary shareholders. Investment banks and private equity money managers take huge fees for themselves in buyout situations, and it is primarily these top insiders who benefit [93]. Ordinary shareholders often lose out, because buyout prices are too low. Do private equity firms really improve the quality of products or add value when they take over public corporations, and end up reaping billions for themselves [49]? Most typically, the answer is no. What they do is manipulate assets and move around paper for their own advantage.

  9. The role of some dimensions of personality cannot be dismissed. A recent Penn State University study suggests that narcissism is especially pronounced among private equity fund managers, and some anecdotal evidence seems to support this as well [108].

  10. Concentrated ownership systems such as those that are dominant in Europe are hardly immune to fraud, but when fraud occurs it tends to take a different form than that found in diversified ownership systems. Coffee [13: 15] describes this type of fraud as “extraction of private benefits” wherein CEOs and corporate managers find ways to divert corporate resources to themselves. This is the essence of what occurred in the Parmalat case, as well as the case of Conrad Black and Hollinger. Of course such frauds have also occurred in the American context, with the father and son Rigases ultimately convicted of having extracted huge sums from the Adelphia corporation for their private benefit. Indeed, in the realm of criminality within the corporate realm no absolute laws can be posited. Different combinations of variables can produce different kinds of fraudulent outcomes.

  11. For example, for purposes of determining the pay of Eli Lilly’s CEO’s, Johnson and Johnson was selected despite the fact that the latter is a much bigger and more diverse company [69].

  12. In his Revolt in the Boardroom: The New Rules of Power in Corporate America, Alan Murray [74] advances the thesis that we are in the midst of a radical change challenging traditional CEO dominance, fueled in part by the high-tech stock bubble bursting, the aftermath of 9/11, and the series of corporate scandals beginning with the Enron case.

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Correspondence to David O. Friedrichs.

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For: Special Issue on White-Collar Crime. Mary Dodge and Gil Geis, Guest Editors. CRIME, LAW & SOCIAL CHANGE

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Friedrichs, D.O. Exorbitant CEO compensation: just reward or grand theft?. Crime Law Soc Change 51, 45–72 (2009). https://doi.org/10.1007/s10611-008-9144-2

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