Introduction

Current levels of executive compensation in Anglo-American firms, particularly CEO pay, have been the subject of public scrutiny, maybe even outrage. Outrage which is understandable given that overall wage growth has stagnated over the past few

decades1_{. Something interested parties have failed to agree on is the reason(s) behind}

the persistent rise, what is needed to curb this rise or whether indeed it should be curbed.

Bebchuk et al argued, that high pay results from corporate governance failures, which

enable rent extraction by company executives2_{. Counter-arguments have sought to}

negate this thesis and regard current pay levels as the proceeds of efficient processes3_.

Arguing, that current pay levels result from an efficient bargaining contest between a disinterested board and a CEO or prospective CEO looking to earn his worth. The preceding is the conventional view of the pay setting process, known as the optimal contracting view.

1 _{Statistics show that with executive pay far outpacing average wages by a ratio of 180:1, 78 per cent}

of the public would support a maximum limit on how much the highest paid could earn in relation to the lowest paid, within any given company. See High Pay Centre Report, ‘Reform Agenda: ‘How to make top pay fairer’ www.highpaycentre.org (accessed on 25/01/2015).

2 _{L. Bebchuk, J.M Fried and D. Walker, ‘Managerial Power and Rent Extraction in the Design of}

Executive Compensation’. The University of Chicago Law Review, [2002]Vol. 69, 751-846.

3 _{Randall S. Thomas, ‘Explaining the International CEO pay Gap: Board Capture or Market Driven’}

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The contrarian argument, states that a flawed governance system allows managers too much power and leaves them in a position of influence over the board, which translates into higher salaries. This, irrespective of whether there is corresponding firm

performance4_{. This theory of the pay setting process is known as board capture}

theory/managerial power approach, intends to highlight the naiveté of the

mainstream arms-length or optimal contracting narrative5_{. They argue, that the latter}

results from vulnerabilities which arise from the hierarchical managerial structure- where some U.S firms have the positions of CEO and board chair vested within the same entity. Also, the fact that managers are usually allowed a broad discretion on issues such as the nomination and dismissal of directors. Highlighting the strong

potential for creating a compromised and captive board6_{. It is safe to assume, that a}

captive board serves, rather than monitors.

These points call into question the justice of Anglo-American executive pay levels. An argument could be made that current pay levels are not just high, but excessive. Given the subjectivity of the latter term, here the Chapter defines excessive pay, as that which exceeds the minimum effective compensation, needed to attract, retain and motivate the recipient to maximise firm value. This definition is premised on the

assumption that managers are inherently self-serving7_.

4 _{Viral Acharya, Marc Gabarro and Paolo Volpin, ‘Competition for Managers, Corporate Governance}

and Incentive Compensation’ July 2013

http://pages.stern.nyu.edu/sternfin/vacharya/public_html/pdfs/AGV_paper_040713.pdf (accessed 15/03/2015).

5 _{Lucien Bebchuk and Jesse Fried, Pay Without performance: The Unfulfilled Promise of Executive}

Compensation. (Harvard University Press; 2004).

6 _{Vincent Warther, ‘Board Effectiveness and Board Dissent: A Model of the Board’s Relationship to}

Management and Shareholders’ Journal of Corporate Finance [1998] Vol.4 53.

7 _{Jeffrey Moriarty ‘How Much Compensation Can CEOs permissibly Accept?’ Business Ethics Quarterly}

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But beyond questions regarding quantum and the excessiveness thereof, is an issue which goes to the core of the high pay debate: the pay setting process. It goes without saying, that failures within the pay setting process not only sully the outcome but ensure its failure to meet required justice standards. To this point Nozick argues, that the process of acquisition, determines the justice of the thing acquired and the holder’s right to it.

The crux of Nozick’s process-oriented view, is that executive compensation is justified

by its process of determination and distribution8_{. Nozick’s libertarian outlook, and its}

predisposition towards “entitlement”, is less concerned with the outcome of the

process-pay quantum-than he is with the process itself. He views any distribution

derived through “justice preserving means” to be just, regardless of the inequities

which may consequence said distribution. To this point he declares, that “whatever

arises from a just situation by just steps is just”9_.

To meet this justice standard, the awarded pay packet must adhere to the core

libertarian principles of voluntarism/liberty, transparency and acquiescence10_{. Which}

implies the absence of inordinate influence by the CEO over the determinative process. As well as the utilisation of clear and easily decipherable performance metrics, set out as part of an accessible remuneration policy and approval by an informed and unbiased shareholding body.

8 _{Ibid, at 237.}

9 _{To Nozick, any holding derived in accordance with the above standard is said to have been obtained}

by a “legitimate means” or process. This includes all holdings acquired by means which are subject to the principle of justice in acquisition and transfer. Robert Nozick ‘Anarchy, State and Utopia’

(Blackwell, 1974) 152.

10 _{Jared Harris ‘How Much is Too Much? A Theoretical Analysis of Executive Compensation from the}

Standpoint of Distributive Justice’ in R. Kolb (ed) The Ethics of Executive Compensation (Blackwell 2006), 67-86 at 81.

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This Chapter is intended to answer the first research question, which is concerned with the integrity of the pay setting process and the compromises therein, which may sully the outcome. As such, it will proceed to examine the issues regarding the pay setting process, exploring the depictions of the latter as an adversarial, arms-length process. As well as those which view the pay setting process as anything but arms-length and adversarial. This Chapter would utilise Nozick’s libertarian theory of entitlement to analyse the pay setting process, in a bid to determine the justice of high executive compensation.

The Chapter therefore will be outlined thus, the following section would consider the conventional narrative on the pay setting process, with its view of the latter as an arm’s length bargaining process. Wherein the independent board negotiates an optimal compensation package with the executive concerned, in a bid to attract, retain and incentivize good performance. The conventional argument for current pay levels is intended to justify the outcome by highlighting the adversarial nature of pay negotiations, which would bring the outcome it in line with Nozick’s thesis. The section would also highlight some of the justifications for current pay levels.

Section three will examine contrasting arguments of managerial interference in the pay setting process, as encapsulated within the board capture/managerial power thesis. There the Chapter would consider arguments which favour a compromised pay setting process and outcome, as well as some of the drawbacks within the corporate governance framework, which inhibit the efficiency of the process.

The following portion will examine the pay setting process, utilising the requirements for a legitimate process-transparency and voluntariness of the transactive process-as

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highlighted by Nozick. Concluding that the highlighted failures within the process of executive pay setting, made it difficult to justify the outcome. This argument was furthered in the final portion of the chapter, where the utilisation of peer-averages was considered in the light of Nozick’s postulation of a legitimate process. The conclusion being, that the basing of an executive’s wage on that of another, could not be considered to be in tandem with Nozick’s process-oriented view of income distribution.