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October 28, 2003
If today's CEOs got paid more because they ran their companies better than CEOs of the 60s and 70s, you might make a case that they deserved the extra loot. But they don't. As the chart shows, during the 80s CEO pay nearly doubled for a given level of corporate profitability, and during the 90s it increased again almost 4x. Overall, a CEO who generates $10 million in net profits today is paid about 7x what a CEO who generated exactly the same amount was paid in 1980. Why? Because they can. When you cut through all the BS, there's not much more to it than that. Now: tell me again why those unionized grocery clerks are just a bunch of greedy bastards for thinking that their pay and benefits ought to rise too? Just curious. Posted by Kevin Drum at October 28, 2003 09:51 AM | TrackBackComments
CEO pay, of course, is set not by the market but by the compensation committees of boards, and the problem of CEO pay won't be solved until the makeup of boards (and therefore comp committees) changes. Which, sadly, will occur shortly after Godot arrives. Posted by: howard at October 28, 2003 09:55 AM | PERMALINKGood chart and valid point! I thought, though, that the 1980s were the decade of greed, not the 1990s. Posted by: Jim at October 28, 2003 10:09 AM | PERMALINKIt's explained by what I call the pie-cutter theory of management: somebody has to be in charge of cutting up the pie, and whoever that is gets to cut himself a nice fat slice. So everyone tries to position himself to be appointed pie-cutter. How do you get to be pie-cutter, you may ask? Well, the pie cutter is appointed by the board of directors, so what you have to do is promise the board that they'll be given a big slice (although certainly not as large as the pie-cutter gets). Once you become pie cutter you have the ability to pick your own overseers, and deny a slice to anybody who dares to point out that you're taking too big of a slice. From that point on, you can cut yourself a bigger and bigger piece of the pie in each succeeding year. It's that simple. Actually running the company and showing a profit [optional] is best left to underlings. You know who's ultimetely at fault here? Institutional investors: Fidelity, T Row Price, Vanguard, et. al. They control enough of the market to force change the system. But they don't, and as such they are not adequately representing the interests of their investors.
I agree that there is a problem with executive compensation, namely that top executives in a lot of companies are getting paid stratospheric sums and not generating stratospheric performance (I have no problem with CEOs making a ton of money if their shareholders are similarly rewarded). But your graph doesn't mean squat. What matters in judging an executive's contribution to corporate performance is the marginal, not absolute, profitability of that company. For example, Coca Cola might be expected to make a $100 million annual profit even if the company had a terrible CEO and paid him $100,000 a year ($1 in CEO pay per $1000 in profit). But say the board decided that they could juice performance by hiring a great CEO and paying him $10 million a year (100 times as much). Assume then that annual profits rose to $150 million. Coca Cola is now paying $67 in CEO pay per $1000 in profit. But shareholders are richer to the tune of about $40 million a year, collectively. So CEO pay per $ of net profit has no neccessary relationship to the link between CEO pay and corporate performance.
Even I don't think I could come up with a complicated chart to explain this. Posted by: John Lotts Calculator at October 28, 2003 10:13 AM | PERMALINKhoward Do you think that (at least some of) the reasoning that compensation committees use is "We need to pay X this much to get them to work here instead of our competitors?" And isn't this market force? Posted by: Ron at October 28, 2003 10:16 AM | PERMALINKNah, some is market forces, but if the board had the true interests of the stock holders in mind it wouldn't pay these stupid salaries. But then again, if stock holders weren't so dumb, they wouldn't invest in these companies. Institutional investors would be smart to demand more say in such decisions. Posted by: Reg at October 28, 2003 10:23 AM | PERMALINKWe'll allocate more money for worker pay, but the new money will be paid out exclusively in the form of performance bonuses based on workers' productivity and quality. For example, the cashiers who checked customers through the lines the fastest (without making too many errors) would get a bonus. The stockers who stocked shelves the fastest would get a bonus. That doesn't even come close to describing the actual issue. You realize it's all about benefits, right? And you realize that pay is roughly equal to the subsequently higher positions workers obtain, right? And they do get annual raises, which aren't that much and could easily be considered cost of living increases, right? And salaries are generally pretty low, you know that, right? Are you familiar with what's going on with the grocers? To Ron: Well, sure, the companies say they need to pay these salaries to attract the candidates they want for CEO positions. And in some narrow sense, that might even be true. But why is that? And, more particularly, why has the market rate for substantially the same talent doing the same job risen so very sharply in recent years? If the boards and compensation committees are doing right by their shareholders, why haven't they found a way to hire top management at a better price, instead of being drawn into bidding wars that favor CEOs? Whatever cause is responsible for pushing up CEO salaries in recent years, (1) I doubt it has anything to do with greater levels of talent, training, or ability on the part of CEOs, as compared to their predecessors of 10 or 20 years ago; (2) I doubt they are creating more value for their employers for some external reason, such as globalization or increases in scale (the compensation per $ profit puts the lie to that); (3) I really doubt you'd see any significant disincentive to take CEO jobs if this increase had not taken place; and (4) I really really doubt that the people who bag groceries are in a position to reap the benefit of the same kind of external shifts in market conditions that CEOs have been enjoying. Posted by: TedL at October 28, 2003 10:33 AM | PERMALINKA related topic might be rationalizing the pay increases of Congress. If they weren't so corruptable, it might be nice to have their pay based on some formula of the median income of taxpayers with an increase if their policies "trickle down" to make America more prosperous. Posted by: ABH at October 28, 2003 10:33 AM | PERMALINKOn the subject of the grocery strike: what would you think if the grocery chains came back to the strikers with the following offer: We'll allocate more money for worker pay, but the new money will be paid out exclusively in the form of performance bonuses based on workers' productivity and quality. For example, the cashiers who checked customers through the lines the fastest (without making too many errors) would get a bonus. The stockers who stocked shelves the fastest would get a bonus. How about if we start doing this with grocery workers after we've given it a testdrive on CEOs for a decade or so? Just to see how it works... Posted by: chris at October 28, 2003 10:35 AM | PERMALINKye gods - reg and i in basic agreement! The market for CEOs is an oligopoly - you've got to be part of the club to even be considered. In addition, since today's comp committee member is tomorrow's CEO candidate, there is a built-in upward bias. (Cultural factors - the era of the heroic CEO - also have provided an upward bias.) In reality, the bell-shaped curve applies to CEOs as well as it does to all other aggregates: there are a handful of superior CEOs, who deserve high pay, but the pay of the superior CEOs, due to the oligopolistic conditions, inflates the pay of the ordinary CEOs. BTW, sd, while your point is well taken, it was as true 40 years ago as it is today, so it shouldn't throw the chart out of whack. Posted by: howard at October 28, 2003 10:35 AM | PERMALINK Do you think that (at least some of) the reasoning that compensation committees use is "We need to pay X this much to get them to work here instead of our competitors?" And isn't this market force? Ahh, but if they were smart, they'd let their competitor overpay for an executive, and save their money for things like marketing or R&D. Such is the ultimate failure of the unfettered free market approach. It assumes that all players in the market have perfect information, and always behave with rationality and intelligence. And now, (It's sad that I have to do this) I'll have to cut the conservative posters off at the pass who are now jumping all over each other to see who can respond with a false dilemma the fastest, that being some variation on "you criticized the market? you must be a socialist", forgetting that there is in fact a vast spectrum of possibilities between unfettered free markets and a true command economy. Posted by: aelph at October 28, 2003 10:37 AM | PERMALINKWhile i was writing my post, TedL wrote his, saying essentially the same thing, but in reading his, i suddenly thought about the Marlins and the Yankees. (Or, for that matter, Moneyball.) Sadly, i'm not sure that most boards can tell the difference between actual performance and reputational performance.... Posted by: howard at October 28, 2003 10:37 AM | PERMALINKA Decade of Greed... it must reflect poorly on the person who was President during that period, right? Posted by: Al at October 28, 2003 10:42 AM | PERMALINKDamn, damn, damn. Jim beat be to the appropriate snark! That'll teach me for trying to post too quickly. Posted by: Al at October 28, 2003 10:43 AM | PERMALINKSD -- Good point. Ceo pay should be linked to the marginal increase in the company's profit above the trend line. The rigth chart would graph the change in CEO pay with the change in corporate profits. If delta pay is rising faster than delta profits, then one of two things could be going on 1) CEOs are responsible for a greater share of the increase in profits, and thus deserving of greater pay. I cannot think of a reason why this would be the case. 2) Pay is not being set according to marginal product. Does that make sense Posted by: Ikram at October 28, 2003 10:43 AM | PERMALINKDoes the graph reflect the change in accounting rules that required the value of CEO stock options to be taken into account? I don't recall when that when into effect, but I do believe that it was some time in the 1990's Posted by: raj at October 28, 2003 10:44 AM | PERMALINKI wish I had the cite, but I recall reading in a business mag that CEOs usually request that their salary be above the industry average -- after all, what self-respecting suit wants to be paid below-average tens of millions? -- and companies routinely acquiesce as a matter of prestige, which of course drives up the average salary, and the whole game starts over again. It's like Lake Wobegone: All the CEOs want to be above average. Posted by: Gregory at October 28, 2003 10:53 AM | PERMALINKTedL I can see the Boards now "Hey, look at what they're paying their CEO over there! We can do better than that!" Occam's Razor, ya know. * My apologies for the use of this phrase, but nothing else has the correct connotations. Posted by: Ron at October 28, 2003 10:53 AM | PERMALINKPart of the reason is that much of this stuff is kept behind closed doors, out of sight. Look at what happens if a local government tries to raise the pay of librarians 2%. Everybody and his brother feels the need to chime in, debating whether the librarians deserve a raise, whether we even need librarians, etc. The issue gets hashed to pieces by people who maybe pay 10 cents towards the librarian's salaries. Those same people happily own stock in companies that are gouging them for much, much more, but it is hidden, and the people don't say a word. There needs to be more public disclosure of this kind of stuff. Posted by: Tripp at October 28, 2003 11:14 AM | PERMALINKA question I've never seen satisfactorily answered is what kept the CEO salaries in check for the years prior to the late 80s? Gregory: if you look at a lot of company proxy statements, the comp committee report will say that the comp committee tries to place the CEO's comp in the 50-75th percentile of a peer group of companies. Yes, that does create a Lake Wobegone effect... And not to pee-pee on my own snark, but I'd like to see the raw #s here, as well. Since the graph plots a ratio, the increase could be due to an increase in the numerator (CEO comp) OR a decrease in the denominator (net profits). We like to think of the 90s as having increasing net profits. BUT - the graph must use as its denominator an average of the net profits of some kind of a group of companies. If the group is somewhat stable (say, the S&P 500), fine. But if the group expanded a lot (say, if it included every public company in existance), the everage might decrease. This might happen, for example, if the group included Webvan and Pets.com... companies that had negative net profits. Posted by: Al at October 28, 2003 11:18 AM | PERMALINKRon: : penis envy. I can see the Boards now "Hey, look at what they're paying their CEO over there! We can do better than that!" In fact there was a piece in the Financial Times just last week making exactly this argument. There's certainly some truth to it. The big point to keep in mind here is that the issue is not primarily the absence of any connection between pay and performce (tho there isn't, of course.) It's the absolute levels of executive pay. What to do? Higher taxes, stronger unions, stiffer reguulations, and a
culture that doesn't celebrate vast personal wealth. There's no
conceptual problem here, just a practical political one. Was it Akerlof who said the tax-cuts-for-some were 'a form of looting'? Doesn't this qualify at least as much for such a label? Posted by: V / VJ at October 28, 2003 11:19 AM | PERMALINKWhat matters in judging an executive's contribution to corporate performance is the marginal, not absolute, profitability of that company. Agreed. Unfortunately, marginal profitability is impossible to measure. To take Coca-Cola as an example, you'd have to make two Coca-Cola corporations, set one as the control to be managed by a run-of-the-mill CEO, and give the other to the CEO star and see if he can out-perform the other by his own salary. Since you can't really measure it, all you can go on is speculation. Kevin's chart, whatever it's flaws may be, is at least based on data. And it shows quite clearly that across the board pay is going
up without profitability going up. I'm sure that there are some CEO's
who earn their pay in marginal profitabilty, but it looks like there are
a bunch of them merely along for the ride. Why? The same reason a dog
licks his balls - because he can. Since the oligarchs are entrenched, it would appear there is pretty much nothing anyone can do except sit back and enjoy the ride. There certainly isn't any way to shame them into shedding their curly tails and taking less baconesque compensation. And the typical American perversely thinks it's kind of cool...as though somehow they will eventually be CEO and be able to feed at the trough. Greed is a part of our culture. Looking out for #1 is our mantra. If I had my druthers, I'd mandate that no upper management can make any more than (insert reasonable percentage here) more than the lowest paid worker in the corporation. Ben & Jerry used to do it until they sold out. Their company was selling a great product and making plenty of money to go around, too. Posted by: chris at October 28, 2003 11:21 AM | PERMALINKMost stock is held by mutual funds or things of that type. These funds are unlikely to pay too much attention since it really isn't there money. Its fairly easy to convince a given manager rep to sign teh proxys over after some wining and dining and perhaps a future job if things don't work out in his current position. The cost is what, a few hundred off the rep's bonus? Comped strippers are definately worth THAT! Posted by: Rob at October 28, 2003 11:21 AM | PERMALINKAnything that can be done to facilitate the owners of corporations behaving more energetically in regards to overseeing management, or to give owners more power in overseeing management, would be worth exploring. It may be that a very long bull market, as we experienced in the last two decades of the 20th century, fosters more inattention on the part of shareholders; when the S&P 500 skyrockets, people are generally satisfied, and generally satisfied people usually don't do as good of job at providing oversight. Posted by: Will Allen at October 28, 2003 11:28 AM | PERMALINKPaulB, from the social historical reading i've done on the matter, CEOs didn't, in earlier eras, think that becoming a CEO was an accomplishment that by itself meant that the CEO should retire among the top .1% of households in terms of wealth. There was a recent book about the Harvard MBA class of something like '48 or so (can't recall the details, don't have time to look up) that discusses this in some detail. What seems to have started driving CEO salaries on the uphill spike is the (sorry Al and Jim) the LBO boom of the '80s, a moment that is captured in Adam Smith's Supermoney.... Posted by: howard at October 28, 2003 11:29 AM | PERMALINKuh clem makes a valid point about the institutional investors probably being able to influence the situation. They can (influence) but won't because they (the big muckity mucks anyway) tend to serve on the same boards. Makes for good prespectus reading. I'm actually for some sort of salary cap. Paying someone 20 million so run a company seems just a bit extreme to me. Paying them a base (minimum) with a sliding scale based on
profitablity would seem fair. I just don't see how the Corporate
Culture is going to change. uh clem wrote: "Unfortunately, marginal profitability is impossible to measure. To take Coca-Cola as an example, you'd have to make two Coca-Cola corporations, set one as the control to be managed by a run-of-the-mill CEO, and give the other to the CEO star and see if he can out-perform the other by his own salary."
But that doesn't mean we can't use some common sense in designing compensation packagaes that are likely to incentivize good performance. If the goal of a corporation is to make money for its shareholders, then setting up a CEO comp plan under which the CEO makes lots of money if the shareholders make lots of money, and vice versa, is the most likely way of getting strong executive performance. The problem with CEO comp in the US is that the specific structure of CEO comp plans allows CEOs to make lots of money even when their performance is mediocre. Designing better comp plans isn't rocket science - you just have to index the company's performance to a broader market basket of securities and look for performance above and beyond that of the peer group. Its just not been a high priority for many years, as both shareholders and CEOs have gotten rich together. Leaner times will lead to new innovations in CEO pay - they always do. On an unrelated note: some posters have asked why CEO comp started
going up dramatically in recent years. Well, it used to be that all
employee salaries were considered a tax deductable business expense, as
they should be. But in a previous era of populist outrage at how much
those greedy CEOs make, a $1 million a year cap was set on CEO pay tax
deductability. When salaries were no longer fully tax deductable, the
most tax-efficient way of paying CEOs became to give them stock options.
Couple that with a decade long bull market, and CEO pay inevtiably
skyrocketed. So be careful what you wish for. An earlier generation of
CEO pay "reformers" created the conditions that drove the CEO pay boom
of the 1990s. Well, yes and no, sd. No one forced comp committees to shower the number of options they showered upon CEOs.... Posted by: howard at October 28, 2003 11:42 AM | PERMALINKSome here have asked why institutional investors don't exercise control over CEO comp. the answer is simple - their ownership stakes tend to be too diffused. A mutual fund or pension fund that held more than a tiny % of a company's stock would probably be doing its investors a disservice, because concentrating large amounts of capital in a few securities leave investors exposed to needless portfolio risk. Don't put all your eggs in one basket, and all that. But when every institutional investor follows the same (entirely right) strategy, no investor is left controlling enough of a company to exercise real control. The solution to this is simple: bring back the LBO. LBOs were structured by swapping the most of the equity in a company for debt and concentrating the remaining equity ownership in the hands of a few investors who had every incentive to make sure that CEOs performed as well as possible. But we tried that in the late 1980s, and a lot of people, including many of the exact same folks who now complain that CEO pay is out of control, bitched about LBOs because they offered a few superstar performers the chance to get wildly rich very fast. So congress passed a lot of law restriction LBOs, and the market for corporate control dried up. There are still LBO funds out there, but they are a much smaller part of the cpital markets than they would be if they were unfettered by silly regulations designed to protect corporate insiders at the expense of shareholders. Posted by: sd at October 28, 2003 11:46 AM | PERMALINKI think all this haggling over CEO salaries is real fun, but is it the question? What are CEO salaries as a % of Cost of Sales? Are we really looking at any impact if those salaries are reduced? (How much of the reduction will go to the line animals and how much to stockholders or reinvestment.) I think there is a disconnect if you think that limiting CEO salaries equals better benefits to grocery clerks. Posted by: Ron at October 28, 2003 11:54 AM | PERMALINKThis is an area where slight changes in securities law could make a big difference. Stockholders aren't allowed to have binding votes on matters that are considered part of management. E.g. a stockholder submitted a resolution that would have required Apple to account for stock options. This resolution was disallowed - we stockholders couldn't vote on it. (IIRC) Broadening what stockholders are allowed to vote on would exert a downward pressure on CEO salaries. Even allowing them more choice in board members (instead of presenting them with management's slate to take or leave) would probably make a difference. Posted by: Emma Anne at October 28, 2003 11:56 AM | PERMALINKRon, of course you're right about how small CEOs salaries are with respect to gross revenues (although not necessarily to net revenues). To repeat, the rub with CEO salaries is that they are the outgrowth of a fixed game, not a marketplace, and that by itself is disgusting and offensive. Posted by: howard at October 28, 2003 12:01 PM | PERMALINKThat chart means precisely nothing. The reasons pay began rising rapidly during the eighties are 1. The adoption of stock options as a primary methodology for paying senior executives and 2) A roaring stock market, making those options far more valuable than anybody anticipated. Having said that, executive pay versus performance is clearly a problem, and those above who point to the interconnectedness of boards/comp committees/compensation consultants have their hands on the issue. While we clearly want CEO's interest allied with shareholders and therefore a tie to stock appreciation is key, I'd do the following: 1. No corporate officer of a public company may sit on the board of another public company; howard says I agree howard, but the only thing that is accomplished by pounding CEO salaries is making the left feel good about supporting the working man. It has no real effect, if that money isn't going to CEO's it will be spread so thin as to be unnoticable. Posted by: Ron at October 28, 2003 12:12 PM | PERMALINKAnyone notice that the real explosion of CEO pay in the graph occurred in the early 1990s, which was right after the gov't enacted that tax measure intended to discourage corporations from paying more than a $1mm annual salary to their CEOs? That legislation is thought to have encouraged the use of options and we know what effect that has had. I'm not sure how "compensation" is measured in the Business Week/S&P study so that is an open question. Does it include options? Posted by: JT at October 28, 2003 12:12 PM | PERMALINKCorporate governance comments are good, but the politics will trump sound business practice everytime. In California, there was a proposal to divest CalPers (California Public Employees Retirement System) from companies that contracted with the state to perform services cheaper than state employees. Why? To protect higher paid state-employee union members (to the detriment of the taxpayers). That is the kind of bullshit that prevents large institutional investors from adopting a clear rule to promote someone else's idea of "appropriate" ceo pay. jw mason posted: "What to do? Higher taxes, stronger unions, stiffer reguulations, and a culture that doesn't celebrate vast personal wealth. There's no conceptual problem here, just a practical political one." Please. This ranks up with black oaks comment above that "$ 20 mil.
to run a company seems extreme to me..." Sure - and $ 16.95 an hour to
bag groceries seems outrageous to my Dad. The perspective of these
comments is all wrong. Is is just as wrong for someone to sneer at the
strikers for having jet-skis and other "expensive" toys. That is their
choice. Want to make millions? Go work on Wall Street. Or even
easier, get a job in sales and get good at it. If you think you are
entitled to just show up at work and have someone tell you what to do -
and have great pay, benefits and lifestyle - you are living in 1950.
[Note: it is not 1950] Ron, while as a lefty i'm happy to pound on the rich who don't deserve it (Bill Gates and Warren Buffett? yes, they deserve it; Gerald Levin and Ken Lay? no they don't), the fact is, determining where else the money could go is neither here nor there. The money belongs not to the CEO but to the shareholders; after all, if a business reduces travel costs by 5%, that doesn't mean much either in terms of the pay of the janitors, but that doesn't mean they shouldn't do it. spc67: so what if executive compensation became more option-based? that doesn't render the chart meaningless. Nobody made comp committees hand out trucksful of options.... Posted by: howard at October 28, 2003 12:19 PM | PERMALINKRe: LBOs, it is pretty clear from the graph that sd has it right and howard has it wrong: LBOs INHIBIT growth in CEO salaries, not contribute to it. How does the graph show that? The graph shows that period in which the most LBOs occurred - the late 80's - is the only period since 1970 in which CEO salaries decreased. That is, the period from 1985-1990 is the only period since 1970 for which the line on the graph went down. Coincidence? I don't think so. Posted by: Al at October 28, 2003 12:31 PM | PERMALINKhoward But I think something important is missing from your assessment. I'll pick on Bill Gates as my example (not to particularly defend Gates, but merely as an example). (And this does not apply to all CEOs)(I think I have ran out of caveats) The risk of starting a company is high (50% failure as I recall), if the reward for success is not also high, there is reduced incentive to start. I don't want to get into an argument on the merits of Microsoft products, but for my example we will say they are the best available (base that on the fact that they are the most widely used). Had Gates not taken the chance to build Microsoft, we would not have Microsoft and software would not be as good as it is. If the reward was not there, would Gates have stuck his neck out to start the company? (Failed companies take quite a toll on those whose start them) Didn't we all benefit from his taking the chance? Do you want to remove the incentive to succeed? Posted by: Ron at October 28, 2003 12:32 PM | PERMALINKThe problems with the current system and the LBOs are conflicts of interest. There are stockholders like Fidelity or Citigroup who are big enough to push through compensation reform, but these big financial conglomerates want the company's underwriting business as well. So they'll lay off the CEO, and in turn management will steer some highly profitable business their way. Similarly with Leveraged Buyouts. The current management wants to buy out the stock of the company and finance it with company debt. To do this, they have to negotiate...with the management of the company. So the management happens to negotiate a very nice deal WITH ITSELF, and the stockholders are kept in the dark as much as possible and get screwed. There are supposed to be feedback mechanisms for corporate governance, but financial companies are so large and have so many tentacles you run into conflicts every time you turn around. Unfortunately for the CEOs, popular anger at this practice is now being exercised in the grand jury room. Posted by: RichK at October 28, 2003 12:40 PM | PERMALINKWhile it is true that no one "made" comp committees give out lots of options, there were certainly great economic incentives for them to do so. As noted above, the $1M limitation on deductability, for one. Combine that with the accounting rules, under which companies can choose not to expense options at all, and you've got major incentives to use options as comp. It would be interesting to see a study of the effect of options. Let's pretend that CEOs were just given cash equal to the value of the option at its grant... how much less comp would CEOs haven made? Would it completely flatten out the graph? Made it only half as steep? Posted by: Al at October 28, 2003 12:40 PM | PERMALINKRon - you have to distinguish between CEO compensation and the increase in value of stock held. Gates didn't make billions of dollars because Microsoft gave him a lot of compensation. In fact, Gates' compensation is really rather moderate (for example, during the height of the boom - FYs 1998, 1999, and 2000, Microsoft paid Gates only about $547,000, $665,000, and $633,000, respectively). Rather, Gates became so wealthy because he held half of the stock of the company (and he didn't receive that stock as compensation, but rather held it since he founded the company), which stock grew in value. It is not the same thing. Posted by: Al at October 28, 2003 12:50 PM | PERMALINKAl Bill Gates is not the question. Whoops, sorry, the figures posted above were the figures for Steve Ballmer. Microsoft paid Gates about $542,000, $623,000, and $639,000 in FYs 1998, 1999, and 2000, respectively. Still, relatively not a lot of money for a CEO of a company (Gates stepped down as CEO in 2000) that makes billions. Posted by: Al at October 28, 2003 12:54 PM | PERMALINKRon - as the Microsoft example shows, the incentive for the "risk of starting a company" is really in the increasing value of the person's stake in the company, not in his salary as CEO. CEOs who come to established companies also need to be incentivized. But as the graph Kevin posted shows, the incentives appear to overcompensate for performance... Posted by: Al at October 28, 2003 01:00 PM | PERMALINKRon, sorry, i wasn't clear enough, i guess. I have no problem with the money that Bill Gates has made - that's why i distinguished between CEOs who deserve a high reward and those who don't. (And yes, let's not forget that as a founder, the question with Gates is a little more complex than for the hired hand ceo). Al, nice to see you talking about real content. I refer to the LBOs of the '80s as a social historical phenomenon in terms of executive compensation, and i stand behind that. I do suggest you track down a copy of Adam Smith's Supermoney, as i noted earlier, to get contemporaneous understanding of the cultural impact. Posted by: howard at October 28, 2003 01:02 PM | PERMALINKI don't want to get into an argument on the merits of Microsoft
products, but for my example we will say they are the best available
(base that on the fact that they are the most widely used). Had Gates
not taken the chance to build Microsoft, we would not have Microsoft and
software would not be as good as it is. Totally off topic but, geesh, next time you're choosing a company to glorify, puh-leeze don't pick Microsoft. The software sucks. They write lazy inept code that costs millions worldwide in lost productivity due to viruses. They are used so much not because they're just so darned good but because they are a monopoly that crushes any competition along the way. Posted by: chris at October 28, 2003 01:11 PM | PERMALINKI notice that the graph for CEO compensation has approximately the same hockey-stick shape as the graph of global temperatures, after the removal of noise. We'd have to get information about CEO pay back to the year 1400 to make sure, though. Posted by: Daryl McCullough at October 28, 2003 01:13 PM | PERMALINKhoward says And that be why I said my example doesn't apply to all CEOs. But as long as you recognize the importance of incentives I'm happy. There was a thread about restaurants a while ago, and I got to thinking about Pizza Hut. A couple of guys took a chance and built a little pizza parlour. The only reason they are filthy rich is scale, I doubt they get much per pizza sold. Without the chance of doing that, who would start a restaurant? chris Ron, just to be absolutely clear: i am all for incentives. Sadly, most CEO comp plans in recent years have had little to do with incentives and a great deal to do with guaranteeing high returns to CEOs no matter what. As a long-time shareholder of Berkshire Hathaway, I commend to you various annual reports in which buffett has discussed CEO incentives, fair and rigged. Posted by: howard at October 28, 2003 01:34 PM | PERMALINKSo much for our much ballyhood judeo-christian values, and the invisible hand guiding a capitalist economy towards greater efficiency. Actually, I think Adam Smith said a laissez-faire economy could only function in a society with moral virtue. Our current system operates in a moral vacuum. Posted by: bogstone at October 28, 2003 01:35 PM | PERMALINKhoward But with the incentive thing, it will be easy to throw the baby out with the bath water. And with hired hand CEOs the impact of salary reduction is still limited. There are better fights. Posted by: Ron at October 28, 2003 01:38 PM | PERMALINKActually, I think Adam Smith said a laissez-faire economy could only function in a society with moral virtue. Our current system operates in a moral vacuum. Those popping sounds you hear are the noises conservative heads make when they explode. Hope you're wearing your hazmat suit, Bogstone. Posted by: chris at October 28, 2003 01:39 PM | PERMALINKRon, just to bring this all the way to closure, that's why i began the comments section by noting that this is a problem of comp committees of boards, whose solution will require a change in boards, and for that, i hold out little hope.... Posted by: howard at October 28, 2003 01:50 PM | PERMALINKI think this conversation is a bit off-balance. Ron:You're mixing up labour with capital. I agree, that to a degree that capital needs to be rewarded for risk..(there's the incentive) However, CEO-dom is, to be blunt, mere labour. There no real risk for the individual. It's just another level of the faceless machine that is a corporation. There's no more risk to the CEO than there is to the factory worker. (I strongly believe there IS risk, as a worker invests their time to the company, which is substantial) Posted by: Karmakin at October 28, 2003 04:03 PM | PERMALINKThe long involved answers, and gneral lack of hope of resolving them, tell me one thing- activities essential to the public must be publicly owned and operated. The Carlyle-Bush cartel is rewriting the history of fraud. Posted by: serial catowner at October 28, 2003 04:05 PM | PERMALINKAs JT points out above, the ramp-up in CEO pay correlates roughly with the Congress's decision to punitively tax all cash compensation above $1MM pa. That was in part responsible for the turn to other forms of exec. comp., i.e., stock options, which, if and when it pays off, pays off really big. Had Congress left exec comp alone, that curve would probably have stayed flat. Posted by: douglevene at October 28, 2003 04:47 PM | PERMALINKdouglevene, do we have to keep going through this? Nobody forced comp committees to hand out truckloads of options that were so easy to turn into cash. That was a choice that comp committees made. I'm fully aware of the Law of Unintended Consequences, but let's not let comp committees off the hook here: they made the decisions that have elevated CEO pay into such stratospheric levels, not congress. Posted by: howard at October 28, 2003 05:15 PM | PERMALINKspc67: so what if executive compensation became more option-based? that doesn't render the chart meaningless. Nobody made comp committees hand out trucksful of options.... No, Howard, as I said in my post, nobody anticipated the explosion in the stock market. Nobody at the time thought that P/E's would change so rapidly. The chart is worthless because it doesn't show how shareholders benefited as well from the expansion in p/e's, not just CEO's. Having said that, I agree this is a problem and I've offered simple solutions which would at least crimp the current system. Richk, Fidelity does no underwriting, Citigroup's two arms, underwriting and investing are not permitted to sell to one another, so those points are just wrong. Posted by: spc67 at October 28, 2003 06:43 PM | PERMALINKspc67, the chart reports comp against profitability; it's perfectly valid. That multiples expanded during the '90s is neither here nor there: the expansion of multiples aggregately in the marketplace had nothing to do with the efforts of an individual CEO. And not all option-compensation deals were struck before multiples expanded, and an astonishingly high percentage were struck at values that would have rewarded CEOs obscenely had multiples not expanded as dramatically. For what it's worth, i agree with you 2-4, don't think that i agree with your number 1. Posted by: howard at October 28, 2003 09:04 PM | PERMALINKDidn't notice if anyone addressed this: Between 1947 and 1979 there was strong income growth at the bottom (120 percent) and theweakest growth at the top (94 percent). That is, there was strong and equalizing growth. In contrast, growth was much slower between 1979 and 1999 (slower overall and on an annual basis). The last twenty years also saw the incomes of those at the bottom stagnate (down 1.4%), while those at the top grew by 42.1 percent (and 65.6 percent for the wealthiest 5 per-cent). --U.S. Trade Deficit Review Commission, 2001 Now do an overlay of ex-im, productivity, and growth in GDP on top of Kevin's CEO graph and you will see that Astronaut is a more appropriate job description. Sorry boys and girls. Good leaders deserve good pay. Great leaders deserve even more, but not at the expense of unit cohesion. What the Economist calls a job that has "never been more demanding" is merely a job that has floated back to earth. It's work, not celebrity. McKinsey's "War for Talent" did for C-Levels what this admistration is fdoing for policy: Inversion of valuation models. Equity trumps Operations, politics trumps policy. "This is partly because of changing corporate structures." Why are they changing? Hmmm. Yes, and I spend all my time trying to "think outside the box" instead of asking myself whether we need a new box. Waiter! Another silo, please. Layers of middle management have gone, so that more divisions report directly to the person at the top. Layers gone? Cool. Add another 1,000,000 to my warrants. Lonely? Buy a dog. "The pace of innovation is quicker, new technologies have to be applied faster and product life-cycles have become shorter." Feed the tigers, ride the horses, shoot the the aforementioned dog. I don't know what the Economist hears, but I hear "improved development times, cyclical windows for leaprog competitive advantage and dynamic markets." What a difference 3 years and a depressed Maria Bartiromo makes. ?I spend my life advising friends of mine not to become chief executives of quoted companies, and by and large they take my advice.? Many look longingly at the more secluded world of private equity. Maybe you'd like a job in government, I hear nobody bothers you there. Now shut up, and get to work. Gee, maybe I was too harsh. Shut up and get to work, it's payday. Bogstone, Adam Smith was wrong--the market system works fine in a moral vacuum. Didn't you see the chart? Signed, The CEOs Posted by: adamsj at October 29, 2003 05:06 AM | PERMALINKKarmakin "hired hand" CEOs are mere labor, yes. The CEOs that I don't want to see pounded on are those that started their business and grew it. They have large amounts of risk early, and they take that risk only because of the long term benefits (incentives). Posted by: Ron at October 29, 2003 05:24 AM | PERMALINK
At least the economy's growing. We're richer than we were in 1960s and 70s. Meanwhile, the kids are getting dumber. (Check NAEP scores against per pupil expenditures, or longitudinal SAT data if you don't believe me.) Posted by: truth teller at October 29, 2003 07:02 AM | PERMALINK"Microsoft software is not the question. Incentives to take risks is the question." Incentives are a useful point, Ron, but it looks to me like a great deal of risk that once was bourne by owners has been transfered to the rank and file, while owners and management keep the proceeds. This explains much popular resentment vs CEO's. Posted by: Yama at October 29, 2003 07:32 AM | PERMALINK...it looks to me like a great deal of risk that once was bourne by owners has been transfered to the rank and file... I'm not following you here. If you are referring to established companies, failure affects CEOs and officers, employees, stockholders, and consumers of the goods/services; so the risk is pretty widely spread. Posted by: Ron at October 29, 2003 07:57 AM | PERMALINKNot when you have examples like that of Jill Barad, late of Mattel, Inc. This is from wallstreetmostwanted.com: "As CEO, destroyed shareholder wealth by leading ill-fated acquisition. Came under fire for missing revenue forecasts by $500 million after assuring investors Mattel would meet revenue targets only weeks earlier. When forced out, Barad received a severance package valued close to $40 million including $700,000 a year for life in benefits. Shortly thereafter, Mattel fired 3,000 workers citing financial difficulties."
To paraphrase F. Scott Fitzgerald, "The CEOs, they're different from you and me........." Posted by: Dark Avenger at October 29, 2003 10:04 AM | PERMALINK" If you are referring to established companies, failure affects CEOs and officers, employees, stockholders, and consumers of the goods/services; so the risk is pretty widely spread." But the consequences of failure have a greater impact on folks that likely can't build the cushion that investors and executives can. Employers' ability to seemlessly shed staff during downturns has inreased dramatically over the past 20 years. This is all part of that 'creative destruction' which is so important to the suucess of capitalism - I do not argue that this is necessarily a bad thing - I do believe we do a poor job of distibuting the pain and/or gain of such activities. Posted by: Yama at October 29, 2003 10:13 AM | PERMALINKBut the consequences of failure have a greater impact on folks that likely can't build the cushion that investors and executives can. I'm not sure all investors have a big cushion, but I understand what you're saying and I agree. But reducing CEO salaries will not affect this. I do believe we do a poor job of distibuting the pain and/or gain of such activities. We'll probably hit an difference of opinion here that we cannot resolve. My belief is that (largely) unrestricted capitalism has raised everyone's standards of living more than any other system could have. Posted by: Ron at October 29, 2003 11:02 AM | PERMALINKI write and I proofread, I preview and I proofread, and I still do stuff like this... But reducing CEO salaries will not affect this I hate to say this, but Kevin really didn't do his homework on this one. He chose to take the easy 'blame it on the capitalist pig' approach, instead of doing the right amount of due diligence to try and figure out the root cause. I think the graph that Kevin posted and his corresponding comments, 'As the chart shows, during the 80s CEO pay nearly doubled for a given level of corporate profitability, and during the 90s it increased again almost 4x. Overall, a CEO who generates $10 million in net profits today is paid about 7x what a CEO who generated exactly the same amount was paid in 1980. Why? Because they can...' are way off base. The main reason for 'overall compensation' increases has to do with tax law changes the IRS made and the performance of the stock markets. JT and Al nailed it! The IRS put in place rules that incent corporations to pay their CEOs no more than $1M in actual salary (cash compensation) annually. They also allow for corporations to grant options without having to account for them as expenses (right or wrong). The thinking is, this helps to incent the CEO to share some of the risk with the avg. shareholder. The CEO's total comp only goes up as he delivers capital appreciation to the owners of the company (a pretty noble thought). Sure, as a ratio compared to the wage of the avg. employee, CEO pay has skewed upward. And I won't even attempt to rationlize some of the crazy pay packages out there (Grasso comes to mind). But, another point that needs to be understood is that a majority of that skewing has been from the massive bull market that recently took place. Almost by default, CEO pay was going to go up as the markets in general drove higher. As to why are the unionized grocery clerks greedy bastards? Because they want the company to shoulder 100% of their health benefits (whether it is in the best interest of the companies owners or not). Just imagine you owning a business. Now imagine your employees healthcare costs (which you have covered to date) sky rocketing 200% in a year or two. Wouldn't you want to get a handle on that cost? Wouldn't you want to ask the employee to share in some of that cost (as it continues to increase)? Wouldn't you want to protect ALL of the employees jobs by asking for a little help on the health care (and not be forced to lay people off)? If you answer No, then you are either ignorant as to business (and what it takes to run one) or blinded by your ideology and not able to admit to the reality of the situation. Either way, I would not want to be a investor in your company as it would not be a viable enterprise for very long. Chris, for about the fourth or fifth time in this thread, Congress doesn't populate comp committees. Chris, I don't have to imagine. I do own a business. Oddly enough, our service is helping other business leaders to avoid walking into propellers just like your hobson's choice. The gist of this thread--at least my previous post addressing it, is that being boss is tough. But it has its perks and you're hardly an oppressed individual. Sarbanes-Oxley is only making them wince more, but by and large the fixes are palliative for markets and investor confidence. While the cat is away and all that. To address your Equity compensation point: As structured in 80-90% of F1000 companies, compensations bear no "true" relationship to performance in "long term", meaningful ways. "Socialism" and safety nets abound for what my company coins? "Insulated Deciders" And "Isolated Deliverers" (workers, employees, voters) are more and more aware of this thanks to information on the net and cable--they see exactly how inequitable things can get. Very Important: Companies must reward performance, but they must also punish failure. That there are two forgiveness standards with no plausible explanation is destroying managerial credibility. This is a discussion that is not happening in boardrooms now in any meaningful measure. Now, precisely when it's needed. Trading and disclosure rules were stretched to the limit the last go round. Executive transactions bear little similarity to "standard trading behaviour". In many cases the appearance of impropriety did far more damage than actual laws broken. Grasso's just an obscene example, but examples are what drive perceptions, not medians and detailed study. Perception is reality, and it's whacking some previously protected people. As to healthcare, well, what many call strikers are really management lockouts, first. Second, this is a looming dustup between lobbyists for competing business sectors with an interesting twist: No-health sectors accusing health-related business of predatory cartel pricing. Wait 5 years and see. Compromise is difficult at any time but in down times everybody's averse to give. Grocery has inelastic demand--gotta eat, eh?--so they can plan far more effectively than say, Tiffany's. Sure margins are thin. But the aformentioned CEOs are AWOL. No ideas. 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