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from: Timothy Noah
to: Robert Reich

Will You Agree That the Market in CEO Pay Is Distorted? Pretty Please?

Posted Tuesday, Nov. 6, 2007, at 7:03 PM ET

Bob,

I agree that the tax code is far too accommodating to rich corporate CEOs and to hedge-fund managers. One of the pleasures of reading Paul Krugman's new book, The Conscience of a Liberal, is to be reminded that during the Eisenhower years the U.S. economy enjoyed explosive growth even though the top income-tax rate was 91 percent! (The tax cut that made John F. Kennedy a hero to supply-side zealots brought that top rate down to 70 percent, or twice what it is today.) In his April 2007 Washington Monthly column, "Tilting at Windmills," our mutual friend Charles Peters demolished Republican claims that Bush's tax cuts were responsible for bringing the unemployment rate down to 4.6 percent:

In the twenty-two years since the end of World War II that unemployment has been less than 5 percent, taxes have been higher than they are now twenty-one times. In thirteen of those years, the top rate was 70 percent or higher. In nine, it was 90 percent. That's right, unemployment less than 5 percent and a tax rate of 90 percent. Actually, in four of those years the unemployment rate was under 4 percent, the lowest it has been.

The economy of that earlier era, as you note in Supercapitalism, was very different from the economy of today—more oligopolistic, more dominated by labor, and more closely regulated by government—but there's no reason to believe that today's super rich would deprive us of their profit-generating talents if we required them to pay more in taxes. The purpose of raising their taxes would not be to punish them for making too much money but rather to make them pay their fair share to fund necessary and vital functions of government. They have more to spare and therefore should pay more.

Since we appear to agree on this point, I won't dwell on it further.

Where we disagree is on the question of whether stratospheric CEO compensation reflects CEOs' true value in the economic sphere. You think that CEO pay is "outrageous," but only from the standpoint of social justice. From a market perspective, you don't think CEO pay is outrageous at all. You think it's economically rational and reflects the CEOs' true value to shareholders. In that sense, the headline that the Wall Street Journal's editorial page slapped on your op-ed—"CEOs Deserve Their Pay" (subscription required)—was perfectly accurate.

In the old days, you write in Supercapitalism, a CEO "did not have to be especially clever or even particularly bright" because the U.S. economy was more plodding and predictable. Today's CEO finds himself in "a different situation."

Rivals are impinging all the time—threatening to lure away consumers all too willing to be lured by a better deal, threatening to hijack investors eager to jump ship at the slightest hint of an upturn in a rival's share price. The modern CEO must therefore be sufficiently ruthless and driven to find and pull the levers that will deliver competitive advantage. There are no standard textbook moves, no well-established strategies to draw upon. … Boards of directors well understand this, which is one reason why executive talent is in such high demand.

That's true, but only up to a point. Even in today's relentlessly competitive global economy, the modern CEO is something less than the Nietzchean superman you describe here. Even when he does his job well, his performance is only one determinant of his corporation's success or failure—a very important determinant, to be sure, but not necessarily the deciding factor. Corporations are complex social organisms, and the factors that make them succeed involve all sorts of human interactions up and down the hierarchy, along with externalities that have nothing to do with corporate personnel at all. This is a reality that the business press, with its relentless focus on any given corporate chairman's personal dynamism (or lack thereof), is reluctant to face.

To whatever extent the CEO's performance is intrinsic to the success or failure of his corporation, that is seldom reflected in his level of compensation. In my earlier column, I cited Graef Crystal's discussion of a business review article arguing that giving the big boss an excess of stock options can actually hurt a corporation by encouraging the boss to take too many risks, the downside of which punish the stockholders more than the boss himself. In a Nov. 12 column, The New Yorker's James Surowiecki applied this logic to the subprime mortgage meltdown. Crystal, as I'm sure you know, has made a career out of cataloging the many, many ways that corporate boards routinely undermine the principle that CEO pay should bear some relationship to the quality of a CEO's performance. Crystal's concern isn't social justice; it's market efficiency. CEO pay, he argues, seldom makes economic sense.

In your response to my column, you argued that no reforms in corporate governance have thus far had any impact on the growth in CEO pay. The whole effort, you suggest, is futile. I invite you to stop short of that question, at least for now, to reconsider a more immediate question: Does CEO pay really make economic sense? Is it a logical allocation of resources? Does it impose economic costs (if nothing else, on employee morale)? I know you've given these questions a lot of thought—certainly more thought than I have—and I just can't believe you see no market distortions here. Again: Let's not worry just yet about whether we can figure out the proper recourse for frustrated stockholders. Is the market in CEO salaries behaving rationally?

Tim

chatterbox
entries
12345
from: Timothy Noah
to: Robert Reich

Will You Agree That the Market in CEO Pay Is Distorted? Pretty Please?

Posted Tuesday, Nov. 6, 2007, at 7:03 PM ET
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Timothy Noah is a senior writer at Slate. Robert B. Reich is professor of public policy at the University of California at Berkeley and author of Supercapitalism: The Transformation of Business, Democracy, and Everyday Life.
Entry 1: Photograph of Robert Reich by J. Emilio Flores/Getty Images. Entry 5: Photograph of Robert Reich by Darren McCollester/Getty Images.
E-mail Timothy Noah at .
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Remarks from the Fray:

High CEO salaries don't make the CEOs work harder or reward what they do as CEOs. They reward hard work and luck when the person was not yet a CEO. In short, they are an incentive for the workers who aspire to be a CEO. In this sense, they are inspiration for others rather than pay for the CEOs.

The system isn't less 'fair' than it was - back when you had to be the boss' son to make that leap. Actually, perhaps it works better. It inspires more people to aspire. That 2 million a year + 7.5 million parachute in case I fail? That could be mine, if I just work hard enough to enter the promised land... so think 600 mid-level execs who work their tails off, cross their fingers and pray. And the board hopes that this draft pick they are hiring works out and their stock goes up.

Is there a class divide? Yes - but the pool of people who can make the jump to the upper reaches of the filthy rich is pretty large, these days, compared to in the past. The aspiration is for the few highly educated professionals and middle management - to which the children of the blue collar and white collar can apsire. Ok, so it takes 2-3 generations to move from fairly poor to filthy rich. That's still pretty good, in historical perspective.

This takes quite a bit out of the moral sting of CEO salaries, which are certainly unfair and ridiculous as payment for services rendered during a tenure as a successful - or especially unsuccessful - CEO.

--BenK

(To reply, click here.)

We know that appearances matter; they affect valuation. We also know that in an exuberant market, valuation trumps dividends when it comes to stock owners. They're not worrying about a steady 5% return on investment. They're interested in the Big Cash-Out when stocks have gone from 15 bucks a share to 350. Hence there is an appetite in the market for feel-good CEOs. CEOs who are adept at painting a smiley on results. CEOs who are clever enough to hide risks off the books. CEOs who are not managers, they're manipulators.

Manipulators are cheesy, immoral, smart, ruthless risk-takers. Some of them, through pure statistical chance if nothing else, will have a track record of successful risk-taking. Those CEOs become the sought-after darlings, the object of a CEO-compensation bidding war, on the belief that if they succeeded in the past, they must know how to succeed again.

Those CEOs raking in hundreds of millions in compensation are invariably those who score highest in both image-making and deal-making. A CEO with a positive track record in both can name his price, and it will be paid. The fact that both image-making and deal-making are risky, and that past success might not always lead to future success where risks are concerned, is lost in greed's distorting lens.

Only a relatively small number of CEOs play the risk game and manage to look good doing it. But their stratospheric compensation exerts a positive pressure on compensations for the rest of industry - just like in the NBA, where even the lowliest performer is a millionaire, because he suits up next to superstars and passes them the ball.

--UrgeIt

(To reply, click here.)

The Eisenhower appeal is bogus. After World War 2, Asia and Europe were left in ruins. The colonial empires sinking. Their currencies tattered. Their industries, struggling to recover. Fortress America was not only untouched, but had the benefit of being the world's creditor, and rebuilder.

So, with the competition temporarily out of service, and US Goods and Services in high demand, are we to expect anything but good times for America? I'll note that Stalinist Russia had superior economic growth compared to every Western nation except the US, does that mean Stalinism is a great economic policy? Since Stalinism couldn't hurt Russia's economic during WW2 recovery, I doubt a 91% marginal rate could either.

Either way, Noah continually demonstrates the lengths to which he will go to justify his interventionist fantasies.

--Cromwellian

(To reply, click here.)

Evelyn Y. Davis has raised some important issues but she would not have persisted as long as she has if she was not so convenient for corporate executives. She makes it easy for them to marginalize all shareholder activists as colorful kooks.

But the journey begun by the Gilberts will be completed not by Evelyn Y. Davis but by the large institutional investors like the pension fund for the members of AFSCME and CalPERS. These investors are behind highly credible and effective shareholder initiatives on "say on pay" and withholding approval for directors who approve outrageous pay packages. Home Depot would not have gone from one of the worst pay packages in history to one of the best without the pressure of the significant, principled, persistent investors who are the best prospect for a genuine market response and the best guarantee of efficient markets.

There's a lot of pressure for "say on pay" and legislation passed the House with overwhelming support. But I think the more effective approach will come from majorty vote requirements, giving shareholders the ability to jettison negigent or corrupt directors.

--nellminow

(To reply, click here.)

(11/17)

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