Focus: Executive pay and performance
economist.com
economist.com
In corporations there will be board compensation committees that hire outside compensation consultants. The consultants will come back with a suggested salary that is the current standard for similar companies plus an additional amount to insure that they "get the best". There are only a small group of such consulting companies and it is in their self interest to inflate executive salaries. Suggesting lower salaries would mean a loss of future business because it is the very same executives that hire them.
For civil service contracts their will be independent government boards set up to negotiate salaries. To insure that the boards are independent they are usually constituted using a political process. As a baseline for salaries they will use formulas based on what other unions make plus a little something extra because "well everyone deserves a raise". As with the executive compensation committee, it is in the self interest of the government compensation boards to be generous. The government boards are appointed positions based on the party in power. Given the capabilities of unions in voter organization, it is fair to say that they at least indirectly hire the compensation board members.
The net result in both cases is spiraling salaries that have no relation to performance.
Incredibly good point... it's the same phenomenon.
We need -- collectively -- in all spheres -- to take a good look at some people and start asking questions like "what exactly is it that you do here? what value do you create that is commensurate with your salary?"
In government this has to happen at the management or political level. In the private sector this needs to happen via shareholder pressure. If shareholders had a brain, they would start agitating for long-term merit-based CEO pay.
On the small scale, it's very easy to ask "what exactly is it that you do here?" to everyone involved in the entity.
I've actually been on municipal boards negotiating with unions and the salaries definitely were not going up more than inflation. But the amount we were spending on employees was in fact skyrocketing.
You know why? Health insurance. Any study showing you one number and omitting the fact that none of that increase actually goes into employees' pockets is lying to you.
Meanwhile CEO compensation has more than quadrupled just since 1989. See http://www.forbes.com/lists/2011/12/ceo-pay-20-year-historic... .
If it's anything like Australia, it's low-level public servants who have the best pay. They typically have very little responsibility, great conditions (public execs have unlimited work hours, but non-execs have fixed hours) and no-one competes for their job because it's hard to get your foot in the door.
OK, looking at the data, there's a lot of "stationary engineers" and "sewage treatment workers" on high pay points. No idea why. Maybe they have a very strong union, or it could be a data error. Or maybe it includes some kind of payout, after a bunch of "stationary engineers" were injured?
Of course it's atypical. It's also an example of spiraling civil service salaries.
If you're gonna be outraged about something, the least you could do is spend 10 minutes at city hall learning about it.
Daniel Kahneman, and Nassim Taleb have spoken about this - essentially that there's no good reason to think CEOs of large companys have any significant control over their company's outcomes. Our judgement is clouded by a combination of hindsight and narrative biases along with a significant underestimation of 'luck'. Kahneman quotes something like a .6 correlation IIRC. So, it CEO performance exists, it's just overestimated.
Kahneman's new book - Thinking Fast and Slow - is an excellent read.
http://www.smh.com.au/opinion/in-dumb-luck-we-can-trust-2012...
Think about the people you know who are good at their job. Do they give a fuck about money if you give them enough that they're taken care of? No, they probably care a lot more about prestige, interesting problems, other ego-feeders besides a silly 8-digit number.
Of course, CEOs are bound to be good negotiators and will negotiate themselves a higher number because why not. But is anyone going to argue that there's a serious quality of life difference between 20 and 100 million?
TBH, if I heard a CEO of a for-profit didn't try to get a higher pay package, I'd be wondering about this CEO's business skill.
That's because you, like all people, suck at thinking rationally.
:D
But it's not what his performance or his quality of life is based on.
Rather, fingers should be pointed at Boards who agree to ridiculous compensation packages.
In reality, the reverse is often true. You can have too much pizza (though it can be fun to try). You can't have too much in your bank account (or investment portfolio).
If I, for example, were making 1m a year as a software engineer but still had to answer to someone else and deal with bullshit (read anything I didn't want to deal with - politics, TPS reports, writing boring software, limits on vacation), I'd still be as unhappy as I would be at twice the pay. More money wouldn't make the situation any more palatable. Getting a position that lessened the bullshit would. That position could take several forms, and there's many different levers (e.g. paid vacation, a position of substantial autonomy) I can pull besides money to increase my satisfaction.
I can't imagine, though, that most CEO's can move those levers drastically. It's not like you can negotiate for a more reasonable board come hiring time. CEO's don't take vacation in the same way you and I do, and even if they did, I'm not sure a CEO who fought to take time away from his company would be thought of favorably.
But you can't have the best pizza in the world without potentially spending thousands of dollars to get yourself to Naples.
That's an extreme example, but I assume those economists mean that almost any category of good can reach arbitrary levels of consumption. If I had several billion dollars, my pizza acquisition budget might literally be 1000x what it is now.
Because I want that apartment on One Central Park that costs $17 million and I want a chauffeur at 50k a year and a PA at 100k a year and someone to take care of my kids for 100k a year (no sketchies). I also want to be able to hire a plane when I want to do I can zoom out to Tripoli or Nigeria when interesting things happen and no private charter will go.
Maybe I'm being the stereotypical New Yorker, but I can see 30, 50, even 100 million dollars whisking away rather fast. You know what traders call $100 million of personal income? A unit. It's the starting point.
Note: CEO pay is not, when done sensibly, where the Board goes "Mark, you look damn handsome today - here is a hundred million. Go wild." It is a structured pay where you try and align incentives, that is, give the CEO upside when he does well and some downside when he doesn't. You want to encourage sensible risk-taking, remove principal-agent issues, and deal with moral hazard. Most pay for CEOs comes in stock grants or via other non-cash instruments. It is also usually not guaranteed up front.
CEO pay in Fortune 500s is upper-class back-scratching. Nothing more. It has nothing to do with performance.
My vanity is technology. I also place a premium on having a living space that is aesthetically pleasing. A colleague of mine gets a similar aesthetic thrill from beautiful clothes. I tend to judge people whose vanities are primarily outward facing, e.g. buying an expensive car not because you appreciate the craftmanship but because you want to look snappy in it, but that's for the potential insecurity it alludes to rather than the indulgence itself.
A $17 million purchase is proportionally peanuts to some people. What you and I may call peanuts is a lifetime of difference to someone in the third world. Classifying materialism on such a high level seems absurd.
Paying $50 million for trophy real estate instead of investing it into better transportation (the only long-term solution to the real estate problem in New York and Silicon Valley) makes a person a douche.
Using a private 747 for casual transportation, logging an unconscionable ecological footprint through the unnecessary combustion of hydrocarbons in enormous amounts, makes one a douche.
Developing a tight social network to keep global society exclusive, closed and impoverished is a douche move.
Corrupting the U.S. political system and getting the world's most powerful nation into an unwinnable War of Corporate Enrichment (Iraq) is a douche move.
Morally speaking, the tip-top upper classes of the U.S. owe their lives to us in the cognitive 1 percent. They are deep in moral debt to us, and what keeps us from collecting is that we have more interesting things to do (in technology, where we can make positive-sum contributions to the world). We have the persuasive capability and the technological know-how to rise up and take them out, Paris 1793 style. We don't, because for enough of us, life remains pretty good. We're not "among them", and they constantly remind us of this fact; but we can work in technology, live pretty well, and generally control our own destinies. If that ever changes, though, those people need to watch the fuck out.
That's why there's no correlation between the pay and the results, and that's why what you're defending is perverse.
Also, there is a correlation between pay and performance. You can't just strike out the empirical record for rhetorical convenience. It's closer tied to portion of pay in low-struck options, etc. versus cash pay but statistically significant nonetheless.
This is the highest voted counter-argument?
But they have an important indirect impact: wealth correlates with power; if you're richer, you can control more businesses, and run them the way you'd like. Thus, high marginal income taxes keep the old guard in power longer, and mean that ambitious people with new ideas take longer to take control.
High income taxes and capital gains taxes will mean that proportionately more of the world's companies will be owned and run by Rockefellers and du Ponts rather than Zuckerbergs.
So, what false assertion did I make?
It's interesting to read the first Forbes 400 list; there's a lot of old money there. Not so much lately.
You're only looking at it from the executive's POV, not the company's. They are looking for the best they can find. It may be worth it to them to pay, $X million more for somebody who scores a 99 on a hypothetical CEO test, compared to somebody who scores only 98. The company wants to get somebody better, and to get that higher quality, they've got to fork over additional compensation.
Of course, companies are frequently wrong in the way that they score their candidates. But that doesn't change the fact that they've bidding on the highest perceived quality.
Anybody who doesn't want the job enough to do it for 10 million but would do it for 100 million is going to SUCK at the job. Period.
I think you're assuming to much in this statement. It's not clear that they would not be willing to do the job for $10 million. But there are 100 different companies who would be willing to pay them that much, and they've got to make a decision somehow. Other things being equal, they'll go with the one that offers the most.
This is exactly what pricing does in a market. It allows the participants to signal the importance of a product to them. That $100million bidder is signalling that it's more important to him to get mister AAA CEO. Is there some reason that we should ignore that bidder's signal?
Was Steve Jobs a $1/year CEO? How about Sergey Brin?
Good leaders typically have different motivations than "I could afford to upgrade my yacht from 10 million to 25 million". I understand that that complicates your economic model, but guess what, it's people we're talking about here.
If they're underpaid, there should be a positive correlation between CEO pay and corporate performance (i.e. the companies that pay the most can hire the best people). If they're overpaid, there should be an inverse correlation (i.e. the companies that pay the most are likely to overpay the most, and thus waste the most money). So the exact middle ground implies--the exact middle ground. I didn't realize the market was so efficient.
The other possibility is that CEO pay or market performance are totally random. But all you need to do is identify a few very effective and very well-paid CEOs to argue that this is false. Just look at e.g. JCP's new CEO (they nabbed him from Apple thanks to, in part, a generous options package).
This might be clearer in another context: it wouldn't surprise me to find out that your average hunger in a given day has no correlation to your daily caloric intake. That wouldn't imply that calories don't satiate hunger; it would imply that most of us eat something close to our daily calorie requirement.
Statistically, the direct effect of CEO pay on the bottom line is dwarfed by the indirect effect of his/her work on the bottom line, making it hard if not impossible to isolate, and so I don't think these numbers quite tell the story you think they do.
No. If there's no correlation between CEO-pay and performance/market cap, finding a few interesting counter-cases doesn't further your argument. Inherent randomness and lack of accounting for other factors are far more likely to be the culprits here than market efficiency.
EDIT: Further, zero correlation isn't a "middle-ground" between positive and negative correlation. If it implies anything it's that one variable (performance/market cap) doesn't depend on another. If there's no correlation, CEOs can still be overpaid, they just can't do worse for their companies as pay increases.
1. There's an efficient market, and CEO pay reflects the extra value they create. In other words, a $100 million CEO is worth $50 million more than a $50 million CEO, so your economic outcome is the same regardless of which one you hire--except that larger companies will extract more value out of a given level of managerial talent, since they can amortize it over more underlings/revenue/whatever.
or
2. CEO pay and company performance are totally random. But for that to be the case, you'd have to deny that there's any such thing as being able to identify and pay for a talented CEO. Maybe! But every time I've interacted with large company CEOs, I've noticed that they tend to be very bright, and they work extremely hard. People who are in the 10th percentile of public company CEOs--the kinds of people who bankrupt companies--still seem to be in about the 90th percentile of smarts and energy.
I don't know of another theory that could explain the data as presented. Either the process is random, or it selects for people with certain valuable skills. If the system tends to promote skilled people, you'd expect the companies they run to have a higher return. Unless, of course, they capture that value for themselves.
You can be extremely bright and work extremely hard and yet fail to produce a desired outcome due to forces beyond your control or understanding. It's human nature to overestimate our degree of control over events, and indeed, CEOs are probably selected for this trait more than other professions. Who wants a CEO who admits he really doesn't have much influence over the fate of a $100B enterprise? No, you want someone who is self-confident to the point of delusion.
But in actuality, all else is never equal. Then we use the outcome of that unequal scenario to judge after the fact who was the smarter and harder-working. In poker you have a very regular, controlled game. Imagine a tournament where some players were randomly given extra aces, then try and figure out who the best players really are. That's the corporate CEO market.
What you're suggesting here is not that there's no correlation, but that there is a latent correlation hidden by the market. Another scenario is that some CEOs do well for their companies and some do poorly and this doesn't depend on how well they're paid. In other words, I'd vote for possibility 2, except instead of saying CEO pay and company performance are totally random, I'd say they're independent of each other.
And that's not hard to believe. If someone had just a 10% chance of running Exxon 1% more profitably, their market value would be $40 million per year.
More likely explanations: various inefficiencies interfere with getting the best, (good) CEOs are not easily attracted by even larger salaries, companies in dire straits need to pay for the damage they're likely to do to a CEO's resume, the study is simply too small. (Teasing out a 0.01% effect is hard!)
The headline might also be true in the economic sense. I'm not especially qualified to judge this.
The article, however, is quoting the apparently private data of one obscure financial research firm. So I'm filing it under Not News.
(I also just noticed that they call Warren Buffet 'underpaid'. The guy earned fifty billion dollars being CEO of Berkshire Hathaway. Calling him 'underpaid' seems like a bit of a technicality.)
The alleged problem is that the vesting/restriction periods for these stock and options is too short, like a few years. I have a pet idea that CEO pay should be mostly in stock that vests quickly but is restricted for a very long mean time, like 20 years. But that's just a pet idea and I bet it would be a very hard sell to potential CEOs.
I also think pay for performance is overrated. It won't help if you have the wrong guy in the first place.
Radically increasing the vesting time means that you would need to grant several times the number of options that you would need to grant for shorter vesting terms, just to maintain parity. The potential dilutive effect for other shareholders (including employees) would be rather large.
True, but with pay-for-performance hiring the wrong guy means you paid less (since he didn't perform).
Further, I don't know of a viable alternative. Don't pay for performance? Now you're dealing with a problem of adverse selection - you're more likely to land with a lemon.
The chief problem with CEO pay is that it exhibits much optionality without compensation to the shareholders for that - if the CEO does well he experiences a gain, if he doesn't, he just gets fired (unless the failure is fraudulent or very public).
Conversely, he found that hedge fund managers have absolutely skyrocketed past everyone else. They have totally blown past any type of normal wage growth and are the real culprit for the "1%" phenomenon.
http://www.econtalk.org/archives/2011/11/kaplan_on_the_i.htm...
Interesting that the overpaid industries are those that i would consider to be less innovative and those that are considered underpaid are the move innovative industries and companies. That is just my opinion however.
I tried to find the article to no avail. This article says no relationship between pay/performance but mentions many previous studies have found a negative correlation: http://www.sef.hku.hk/upload/faculty/42/officer-remuneration...
Fantanomics.
http://michaelochurch.wordpress.com/2010/11/22/pay-more-get-...
It's not possible to tease out the cause and effect.
Fortunately there is an easier way to figure it out; if the businesses are hiring idiots, at far to much money the easy way to tell they are doing it is their stock price will plummet and they will go out of business.
It also has increased for workers, and most comparisons (including Michael's) look at the ratio between top executive comp and average worker comp.
A really significant difference that I rarely see acknowledged in these discussions is that the means of compensation has changed drastically in the last few decades.
It used to be that executives got part of their compensation through perks like generous expense accounts, or country club memberships, or keys to the executive washroom. Changes in tax laws and other cultural norms have eliminated these as such. But the corporations still need to be able to compete for the same pool of executives, and so the money that had been going into those perks now surfaces as monetary compensation.
In other words, much of the apparent increase in salaries is actually just that part of the old-days compensation wasn't reflected as income.
How can you possibly make the assumption that companies are run worse today than 70's? What quantitative measurements show this 'steep negative correlation'?
TLDR: if there was any weight to your thesis (which is, what, exactly?), you totally discredited yourself with your cynicism.