11 The amount of executive compensation

The second question that arises from the findings of the first part of this research is related to the way that the amount of executive compensation is determined. Are executives overpaid or not? A theoretical approach to this question demonstrates that critical comments can be made about the arm’s length discussions between the supervisory board (i.e. non-executive directors) and the executives of the board of management (i.e. executive directors) about their remuneration.

The heart of the problem can only be revealed, however, by taking an institutional approach to the determination of executive compensation. It turns out that supervisory board members perceive themselves to be at the mercy of the market when determining executive compensation. This perception is primarily the result of the practice of using an external peer group when determining executive compensation. The roots of this practice lie in the assumption that there is an efficient national and international market for executives.

Based on my findings, such a market is actually a figment that bears no relation to reality. What is even more important is that the threat that executives will transfer to one of the peer groups is simply not realistic enough for a sitting executive to justify the current process of benchmarking. This applies in particular to the larger listed companies. Executives are seldom exchanged on a talent market. If the option to renegotiate in the event of an outside offer is also taken into consideration, it will be clear that peer groups are largely irrelevant in determining the ex ante amount of remuneration.

The aforementioned does not mean, however, that peer groups would never be useful. Think, for example, of the situation where the amount of remuneration for the CEO is taken as the barometer for the remuneration of the various layers under the board of management. The virtually exclusive emphasis placed in recent decades on external references when determining the ex ante level of executive compensation is without basis, however, and does not justify remuneration levels that are not in the interests of the company. Determining the ex ante amount on the basis of an external reference has therefore led to an unjust remuneration development with the result that the pay gap between the top and the rest of the company has structurally increased. As a result, executives not only receive higher remuneration than necessary – unhealthy relationships within the companies are also created with the inherent risk that the productivity of employees declines and the costs increase due to demotivation and reduced morality. This identifies the second key problem justifying the re-evaluation of the current way that the ex ante amount of the executive compensation is determined.