Blog Post # 4: Is a bonus earned because profits are earned?

http://blogs.wsj.com/experts/2016/09/18/why-basing-executive-compensation-on-a-formula-doesnt-work/

 

In executive compensation, a common rule of thumb is to create a performance based payscale. An obvious way of doing this would be to base bonuses and the like on quantifiable business metrics such as stock prices, or total shareholder return.These rules are simple to follow, and make sense, but they fall prey to similar concerns raised by recent readings for our class: they can be stupidly followed or even maliciously followed. The formulas can also be so heavily impacted by outside factors that the compensation will be unfairly earned or unearned. As a result of this issue with the practice, there is a shift back towards a more discretionary philosophy of executive compensation.

This concept of rule based ethics being flawed is a concept that dates back to ancient Greece. It is a primary plot point in Plato’s “Euthyphro Problem”. This is a work Plato wrote down about Socrates’ conversation with Euthyphro, who will also be headed to athenian court over supposed transgressions. In Euthyphro’s case, he wishes to prosecute his own father for slitting a servant’s throat. In this work Socrates inquires as to what is pious, and if simply following rules is enough to be ethical. In this work, it becomes fairly obvious that always following the rules isn’t enough. The issue of rule based ethics was also recently covered in our textbook readings, in a more modern manner.

Getting back to executive compensation, the move back towards discretionary executive compensation is dangerous. If cronyism is reborn among varying corporations, as it appears to be at certain banks that, in spite of being bankrupt, have been giving egregious raises to their executives. Though the rules and formulas for compensation are proving to be somewhat flawed, the discretionary process is very, very easily corrupted, as shown in the before-mentioned corporations. The formulas do root out certain possibilities for negligence of both stupidity and malicious intent, which would be a good starting place to clean up the ethics of companies, and the murky waters of executive compensation.

http://blogs.wsj.com/experts/2016/09/18/why-basing-executive-compensation-on-a-formula-doesnt-work/

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