Executive Cap by Congress Is Counterproductive Alternative

Article excerpt

Survey suggests that defense industry comes up short in overall exec compensation sweepstakes

Congress, several government oversight audit agencies, and numerous shareholder rights groups during the past several years have focused their attention on the reasonableness of the executive compensation arrangement for companies doing business with Uncle Sam.

They, particularly, have been concerned with the magnitude of chief executive officer pay.

They have charged that executive pay has exceeded levels required by market pressures, and that CEO compensation has become an excessive free-for-all divorced from the reality of corporate results.

The seminal question should be: Is executive compensation predicated on the concept of reasonableness. Further, before rushing to judgment, care should be taken to determine whether government contractor CEOs are paid at a level above their counterparts in commercial enterprises.

Given the current economic and regulatory environment, the issue of reasonableness can prove to be a heavy burden for a company. Recent shareholder dissatisfaction with some egregious CEO pay practices are reflected in efforts by shareholder activists and some members of Congress to limit executive pay.

Assaults on Executive Pay

At a more direct level, government agencies, such as the Internal Revenue Service and the Defense Contract Audit Agency, regularly challenge companies on the amount of executive pay they can deduct as a compensation expense. Additionally, Defense Department appropriations bills for both fiscal years 1995 and 1996 contain language limiting compensation to $250,000 for any one executive in 1995 and $200,000 in 1996.

More recently, the Office of Management and Budget, responding to a directive from Congress, proposed legislation called the Contract Cost Act of 1997. Under this legislation, federal agencies would use the median of various salary surveys to determine the level of executive pay.

Sen. Tom Harkin (D-IA), however, faulted this remedy for its "flawed methodology."

"In effect," he asserted, "the more an industry sector pays its senior executives, the more the federal government would allow a contractor. Even a cursory examination of the current levels of executive compensation shows that allowability could rise to several times more than the current statutory cap, perhaps reaching millions of dollars."

Sen. Harkin also observed that the proposed legislation does nothing to set pay in accordance with an executive's performance.

Key Considerations

Sen. Harkin may have missed the central issues of this case, that include:

Is the market for executive compensation flawed and will the congressionally imposed cap of $250,000 solve the perceived imbalance between executive pay and company performance?

Do executives who work for government contractors receive pay significantly in excess of that received by their peers working in a commercial environment?

Will placing an artificial cap on the executive compensation arrangements of government contractors have a deleterious effect on the quality of the talent available to these companies?

The OMB alternative appears to suggest that decisions on executive pay should follow market practice. Some observers contend that in a free market, the forces of supply and demand interact to set executive pay levels and that government intervention is not required.

Critics of this position maintain that the argument would be compelling if the demand for executives was in perfect equilibrium with the intersection of the supply and demand curves. Unfortunately, this consummate situation does not exist in the actual market, thus, leaving the determination of "market rates" to other forces.

Clearly, CEOs and other senior executives do not compete for open positions on the basis of the price they will charge for their labor, nor do companies solicit bids for vacant executive positions on the basis of the lowest rate offered. …