A Theory of Justice for Management Compensation

Abstract

Justice is one of the main drivers of the political discourse about management compensation. High salaries, particularly if they were paid out in spite of lacklustre corporate or individual performance, are regularly lambasted for being unfair or even immoral. The salaries paid within the finance industry before and after the financial crisis earned particular scorn. As a consequence, large parts of the population favour political action towards reining in unjust corporate salary practices. In this article I explore the concept of justice and its ramifications for the public and academic discourse about management pay. I show that justice can indeed be used as a benchmark. Even though reflections on justice do not lead to clear and unambiguous answers about proper compensation standards, they help streamline the search for optimal arrangements. Modern notions of justice have to be tied in with the fact that economic activity is coordinated by markets. Yet, the legitimacy of markets rests on the assumption that economic rewards are earned in a fair competitive setting and reflect real I argue that this implicit social contract is at the core of the discussion about just management compensation. Its perceived violation by large international corporations has left a widespread sense of injustice among the public. Against this background, there are three approaches to justice that can be differentiated: procedural, substantive and ethical. Procedural justice requires that management salaries be set by fair competition and arm's length bargaining, i.e. unaffected by vested power positions or conflicts of interest. Substantive justice is captured by the notion of pay for performance. Ethical justice refers to an attitude of reasonable restraint as opposed to unfettered greed. All three justice notions are relevant. They are complementary and can work as (partial) substitutes. But for all practical purposes, procedural and substantive justice are key.