It is disturbing how brazenly corporate executives have grabbed ever-bigger compensation packages. The facts are stunning. Steve Jobs’s successor at Apple, Tim Cook, pulled in more compensation in 2011 than any other CEO in the United States. The figure came to a whopping $378 million, a price tag that must have eaten up the profits from quite a few iPad sales. Cook’s pay cut in 2012 to a mere $4.2 million probably did not alarm him since the value of his 2011 stock grants had rocketed to $510 million. Larry Ellison, CEO of Oracle, might have felt snubbed when his company paid him a paltry $77.6 million in 2011, but he must have recovered from his disappointment when Oracle’s board of directors raised his pay to $96.2 million in 2012. Lavish CEO pay is not limited to the technology sector. David E. Simon of Simon Property Group raked in $137.0 million in 2011, Leslie Moonves of CBS scored a $68.4 million paycheck the same year, and Brett Roberts of Credit Acceptance made a hefty $54.3 million in 2012. These astronomical numbers are not aberrations. The average pay in 2012 for the CEOs of the S&P 500 companies was $12.3 million.
Even more disconcerting, the upward march of CEO compensation has continued. CEO pay increased about 8% in 2012. In 2011, the average pay for CEOs of the top 500 U.S. companies rose 15%. That jump followed a 28% spike in 2010. The prosperity that top management enjoys would not be so distressing if the wages of ordinary workers kept pace. Unfortunately, this is not so. Adjusted for inflation, workers saw their wages fall 2% in 2011. Taking a broader view is even more sobering. From 1978–2011, the pay of workers rose a modest 5.7%, while the compensation of CEOs ballooned more than 725%. In 1978, CEOs on average earned a reasonable 26.5 times as much as ordinary workers. By 2012 this ratio had catapulted to 354 to 1.
The public’s uproar over excessive executive compensation is understandable. The system seems rigged against the average worker. To people who live from paycheck to paycheck, the scale of CEO pay is incomprehensible. People wonder how much value CEOs bring to companies, especially in the aftermath of the financial crisis when the reckless risk-taking of many of the most respected and highly paid CEOs brought their companies and the country to the brink of financial ruin.
The question is how to correct the inequities of corporate pay. Reformers have proposed numerous solutions ranging from tax policy aimed at incentivizing lower executive pay to mandatory say-on-pay proxy votes to enhanced proxy disclosures. None of these proposed solutions has worked.
Litigation is another approach for controlling excessive executive compensation. Faced with skyrocketing compensation packages for high-level managers, shareholders of both closely held and publicly traded companies have initiated derivative suits challenging the plundering of their corporations. This tactic has also failed. A web of substantive law and procedural rules that protect officers and directors dooms most shareholder derivative claims. The principal culprit is the business judgment rule. Directors are not liable for breach of fiduciary duty to a corporation unless gross negligence, bad faith, or self-dealing tainted their decisions, or the decision had no rational business purpose. If a plaintiff does not meet this burden, the business judgment rule will prevent a judge from even looking at the magnitude and justification for a manager’s compensation. Applying this rule, courts routinely reject challenges to outrageous compensation packages.
Arbitration is an efficient method of alternative dispute resolution that may provide an effective means for reversing this travesty. The parties to executive compensation disputes may select arbitrators who have the requisite expertise. In addition, arbitration is economical, dispensing with many of the costly and time-consuming procedural formalities of litigation. Perhaps most importantly, arbitrators are generally not bound by procedural or substantive law. They may rely on their own sense of justice, fashioning rules of decision based on fairness rather than formalism. The flexibility to diverge from rules of law means that, when confronted with a challenge to excessive executive compensation, arbitrators may ignore the burdensome business judgment rule and other similar laws that make judicial review of even the most outrageous compensation packages a virtual impossibility. Free of these constraints, arbitrators can evaluate challenges to outlandish compensation packages. Guided by their experience and their sense of justice, they might sustain challenges that judges would reject.