Comparison ShoppingThe real reason CEO compensation got out of hand.
Posted Monday, May 11, 2009, at 6:08 PM ET
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StumbleUponIn addition to arming shareholders and corporate watchdogs with better information on how compensation gets decided, the ruling provided financial economists Michael Faulkender and Jun Yang with an opportunity to compare the chosen peers with the peer might-have-beens. The researchers combed through the SEC filings of more than 600 companies, recording the set of peer CEOs that informed executive compensation decisions. For each CEO, they also assembled their own group of peers based on their own calculations of which other executives were most similar.
A thoroughly compromised compensation committee would pick peer firms that are larger, more profitable, and otherwise more likely to have high-earning CEOs than their own. Yet Faulkender and Yang found that by and large, there was enormous overlap between their list of peers and the ones actually chosen, so that compensation committees were for the most part being "kept honest" in choosing pay benchmarks. (Which is not to say there haven't been some flagrant exceptions to this in the past. In justifying Dick Grasso's enormous compensation package at the New York Stock Exchange—a nonprofit—the peer lists included such financial goliaths as Citigroup and Wells Fargo but no other stock exchange or nonprofit organization.)
Yet discretion did have its benefits, at least for the CEOs. The peer CEOs selected by compensation committees had total earnings that averaged nearly $850,000 more than those of ignored potential peers. The authors also calculate that each dollar of extra pay among peer CEOs was used to justify an extra $0.50 in pay, so that the favorable selection of peers resulted in more than $400,000 extra for the CEO's pay. Four hundred thousand dollars may not sound like a lot to a public accustomed to reading of $100 million bonuses to Wall Street superstars. But relative to the average CEO, with earnings of around $6.5 million, it represents a more than 5 percent pay hike.
More importantly, one executive's raise feeds into the pay hikes of others, as yet other companies will use the now 5 percent higher paycheck as a peer comparison next year. Add to the mix the fact that every year a few corporate leaders are awarded outsize compensations that allow them to leapfrog their competitors' pays (perhaps because of an exceptionally weak board, threats of retirement, or other unusual circumstances), becoming the new standard for pay comparisons in the process, and it's easy to see how a few decades of favorable peer lists could snowball into the enormous incomes we're seeing today. In fact, according to the calculations of sociologists Tom DiPrete, Greg Eirich, and Matthew Pittinsky, it is possible to account for much of the recent rise in executive pay based on the positive feedback loop and interrelatedness among CEOs' pay.
Why do compensation committees err on the side of generosity in spending shareholders' dollars on CEO pay? We all want to be a little better than average, and for board members who like to think they have an above-average CEO, this may translate into the choice of a relatively favorable pay package and a set of peers to match. Also, while boards may not be the CEO's lapdogs, they still have to face one another at future meetings (or at the country club), so when given discretion in matters of pay, it's not surprising that the board may err somewhat on the side of generosity.
This explanation for runaway salaries in the corner office isn't going to sell a lot of papers—there aren't any insidious backroom conspiracies to spin into a story of intrigue. Yet for the very same reasons, it comes across as a more likely account for the rise in CEO pay—compensation committee members are normal people, not conscienceless scoundrels, who are for the most part doing their best to attract and retain leaders. Moreover, the lesson isn't that we should dump the baby of peer comparison out with the bathwater. If CEOs and others should earn "what the market will bear," how better to figure this out than to look at how the market is treating other CEOs? But this CEO labor market will work only if all companies also keep an eye on the more basic market principle that higher CEO pay must first and foremost be tied to the success of the companies they lead.
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There's a much deeper reason for high CEO salaries: MBA-type managers have become something suspiciously like our new ruling class. The brilliant James Burnham presciently called the shot in his 1941 "The Managerial Revolution," which ought to be required reading for whoever wants to understand what's going on in the modern business world.
The fundamental idea is that "management" is something that can be taught as a separate skill, so that, say, anybody who has mastered this skill to the point that he is capable of functioning as the CEO of PepsiCola can slide into the CEO slot of Apple Computer and do just as well, since managing is managing, and does not require any profound understanding of the product in question. And the cult of the manager has metastasized into other sectors of our society.
Now our educational system is being run by similar "manager"-type administrators, often with meager scholarly credentials, and what is being are taught in our military academics looks a lot more like "management skills" than military science as traditionally understood. The common denominators of mangers, no matter what sphere they are operating in, are an overpowering desire to feather their own nests and a philosophy that the rewards they receive should be tied to the size of the budget they control, but not, God forbid, to the quality of their performance or their actual value to the organization..
They look and behave, in short, exceedingly like the higher clergy of the Catholic Church just before Martin Luther came along. (Getting back to Apple Computer, one of the reasons I adore that company is that the managers who ran it in the 1990's were incompetent boobs who nearly drove it into the ground, and when its co-founder Steve Jobs came back, having been given the boot by said managers, he turned Apple around almost overnight and now it is one of America's healthiest and most profitable corporations).
-- dfs
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In sum - the market decides what CEOs get paid.
Shocking- barring some underhanded dealings here and there, as if that doesn't happen in government jobs and contracts, CEOs get paid what the market can bear.
One stat that if often thrown out here is how CEO salary has increased disproportionately with workers salaries over the last 50 years. I find this statistic disingenuous. Has working in a factory assembly line changed all that much over the last 50 years?
Look at McDonalds. Over the last 50 years working there has gotten easier. The cooking is automated and timed. Cleaning the store and managing the store have been the same over 50 years. The jobs have not become more complicated. Now look at the CEO of McDonalds- he or she must manage over a million employees, serves millions of customers daily, operates in over 100 countries, and manages other brands as well. Has the CEO of McDonalds job changed 300% since 1950?
-- gunsmoke
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A lot of people are rediscovering Eisenhower these days. That is, the top marginal tax rates from FDR to LBJ were more than 90%. Something they didn't exactly teach in my high school history class (or, apparently, the high school classes of the 'teabaggers').
The fact is, though, darned few people made income up to the rates that got them up to 90% marginal-dollar taxes. With those kind of rates, the optimal strategy for an executive was to build a nice, boring, stable, long-lasting company that would pay you a nice high-six-figure (in present terms) corner-office golf-playing salary long into your dotage.
Today? Your marginal tax is pretty much always the same if you're in the boardroom. So it doesn't matter if you get it on one year or 50. Your best bet, then? Bird in the hand, baby. Cash today. Throw all the chips on red. Goose the quarterly. Stupid CEO tricks. Whatever it takes to get a big-time bonus if you win or a big-time Fiorina-sized severance if you fail.
-- ordinarulo
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