A philosophical and economic inquiry into corporate executive salaries

Elaurant, Scott (2011). A philosophical and economic inquiry into corporate executive salaries PhD Thesis, School of History, Philosophy, Religion and Classics, The University of Queensland. doi:10.14264/uql.2014.427

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Author Elaurant, Scott
Thesis Title A philosophical and economic inquiry into corporate executive salaries
School, Centre or Institute School of History, Philosophy, Religion and Classics
Institution The University of Queensland
DOI 10.14264/uql.2014.427
Publication date 2011-08
Thesis type PhD Thesis
Open Access Status Other
Supervisor Julian Lamont
Fred D'Agostino
Total pages 273
Language eng
Subjects 1402 Applied Economics
Formatted abstract
Over the past three decades the level of corporate executive salaries has risen dramatically, prompting community concern. This thesis is an investigation of corporate executive salaries, considered against the principles of distributive justice and economic efficiency. This will then enable the determination of whether the concerns are valid.

I commence by examining empirical evidence for relationships between corporate performance and executive salary levels in Australia and the United States. I find that there is a weak correlation between executive salary and corporate performance in Australia, and no reliable relationship evidenced in the United States. There is some evidence that high executive salary may be associated with greater risk of corporate collapse in the United States. Looking wider, there is no evidence that higher executive levels result in greater economic efficiency or returns to shareholders, in the OECD countries for which evidence is available.

Given the lack of an empirical justification for current executive salary levels, I next review the philosophical and economic theories that have been used to analyse them, to see whether it is possible to define what executive salaries should be. Philosophically the preferable approach is David Miller’s market rate theory, which justifies salary levels based on the fairness of the markets that set them. The executive salary market fails to meet Miller’s conditions for non-exploitive markets.

In economics, executive salaries have been recognised as an example of the principle-agent problem since the 1970s. The recent debate over executive salary levels has been dominated by two rival theories. Management power theory, as defined by Bebchuk and Freid, argues that executive salary levels are the result of the exploitation of positional power by executives. Alignment theory, as defined by Jensen and Murphy, argues that the principle-agent problem can be solved by incentive based contracts, and therefore executive salary levels are defensible as their free market outcome.

I conclude that management power is strongly preferable to alignment theory as an explanation of current executive salary practices and levels. Alignment theory suffers from circular reasoning and inadequate evidentiary support, despite being developed on an empirical basis. The increase in executive salary levels since the 1970s is due to increased management power. This increase can be explained by the more indirect nature of share ownership that has evolved in parallel with institutional share funds. This has added additional layers of agency costs to share ownership, and created the potential for collusive games between share fund managers, corporate directors, and executives.

Having established that executive salary levels in Australia and the United States are not economically efficient, not ethically justifiable, and caused by systemic weaknesses in corporate governance structures, I consider the case for government regulation.

I conclude that this is both necessary and appropriate, as the cost of regulation is likely to be very much less than the current losses from excessive executive salaries. Reforms need to include both direct salary caps and bonus limits on executive salaries in publicly listed corporations, as well as major overhauls to voting rules for the election of corporate directors and binding votes on remuneration. A further equally important reform is the extension of current corporate governance regimes to share funds. I conclude on a somewhat pessimistic note, pointing out that corporate executives wield enormous political influence, making reform difficult. This is due to their ability to use corporate financial resources to influence politicians to advance their private interests. This “executive influence” theory is consistent with public choice theory first identified in the 1960s. There is now an imbalance in political power between corporate executives and all other citizens. Without reform, the misuse of corporate power by executives is likely to be a continuing problem for capitalist democracies into the future.
Keyword Applied ethics
Distributive justice
Economic efficiencies
Executive compensation
Corporate Governance

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Created: Thu, 10 Nov 2011, 20:01:01 EST by Mr Scott Elaurant on behalf of Scholarly Communication and Digitisation Service