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from: Robert Reich
to: Timothy Noah

To Explain Is Not To Justify

Posted Wednesday, Nov. 7, 2007, at 12:50 PM ET

Tim,

If you agree with me that 1) CEO pay is outrageous on social and ethical grounds; 2) the best way to rein it in (and rein in the even more outrageous pay of hedge-fund and private-equity fund managers) is by increasing the marginal tax on the highest incomes; and 3) shareholders won't and can't be counted on to do the job, then our disagreement is over the economics of CEO pay. You say the current level can't be explained by supply and demand; I say it can—at least, to a very large degree.

There's an important difference between explanation and justification.

Markets have lots of effects that cannot be justified morally—a point that market fundamentalists on the right often fail to acknowledge. One of the biggest of such effects is CEO pay, and the growing gap between it and the wages of average workers. Every two weeks, Lee Scott Jr. of Wal-Mart rakes in roughly the same amount his average employee earns in a lifetime. That's a bigger gap than used to be the case, even at Wal-Mart. Is it because CEOs such as Scott have become greedier than they used to be, or so much more adept at packing their boards with cronies who will award them princely sums? I doubt it. CEOs have always been greedy, and they used to have an easier time handpicking their boards than they do now in the post-Enron era.

A simpler explanation is that boards of directors choose their CEOs from a relatively small pool of proven executive talent. Few executives have been tested and succeeded at the top job. Boards don't want to risk error. The cost of recruiting the wrong person can be huge. This wasn't nearly as much the case decades ago, when competition for investors and customers was far less intense and shareholders were far more placid. But under supercompetitive capitalism, boards are willing to pay more and more for CEOs because their rivals are paying more and more, and the cost of making a bad decision is so much greater than before. As I argue in Supercapitalism, the stakes are higher because, in effect, consumers and investors have more choice than ever before, and are pressuring all companies to offer them better deals. If they don't get them, consumers and investors will find them somewhere else.

This doesn't mean CEOs have to be Nietzschean supermen or -women. And of course a company's overall performance depends on a lot more than the wisdom of a single head honcho. It just means that boards of directors are willing to pay far more than they used to, just as Hollywood studios are paying lots more for celebrities. As The New Yorker's James Surowiecki has reminded us, Clark Gable earned $100,000 a picture in the 1940s, which translates into roughly $800,000 today. But that was when Hollywood was dominated by a handful of big studios. Today, Tom Hanks makes closer to $20 million per film. Movie studios are now competing intensely not only with one another but with every other form of entertainment. They're willing to pay Hanks and other celebrities these colossal sums because they're still small compared with the money these stars bring in and the profits they generate.

Last year, Ford Motor Co.—which, as everyone knows, has been slashing its payrolls—gave its chief executive, Alan Mulally, a $2 million "base salary," $7.5 million as a signing bonus, options and stock units valued at more than $15 million, and more than $11 million worth of other perks and benefits, for a grand total of around $36 million. Did the Ford board offer Mulally this much because Mulally had filled the board with golfing buddies? No. He hadn't even worked at Ford before being offered this package. It was put together by Ford's board in order to lure Mulally to Ford from Boeing. Mulally had done well at Boeing, and Ford was desperate to find someone who could turn around the company and, just as importantly, convince Wall Street it had found someone who could turn around the company. Is Mulally "worth it" in social or moral or ethical terms? Of course not. Is it nonetheless understandable that Ford's board felt it needed him, and therefore was willing to pay him this much? Sadly, the answer is yes.

That the market for CEOs results in such exorbitant levels of pay doesn't make it right to pay CEOs this much; it only makes such pay understandable. This is why I've argued that we can't rely on shareholders to rein in CEO pay. It's also why our understandable moral outrage about CEO pay should be directed at changing the rules of the game—such as increasing the marginal tax on the super-rich.

Bob

chatterbox
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from: Robert Reich
to: Timothy Noah

To Explain Is Not To Justify

Posted Wednesday, Nov. 7, 2007, at 12:50 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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