Comparison ShoppingThe real reason CEO compensation got out of hand.
Posted Monday, May 11, 2009, at 6:08 PM ET
Last fall, with headlines of million-dollar Wall Street bonuses appearing amid the worst economic crisis in a generation, I attended a lecture on corporate ethics by the CEO of one of America's most venerable corporations. This captain of American industry was critical of the compensation committees and formulas that generated these outsize payouts and felt that in his own case, he didn't deserve more than $10 million, regardless of what the committee came up with.
It is truly a statement of the times we live in that a self-imposed $10 million pay cap is a sign of modesty and virtue. Half a century ago, the median pay of top executives in U.S. companies was 30 times an average worker's salary; by 2005, the ratio was nearly 110. How did we get here?
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StumbleUponThe popular (and populist) perception is that of America's CEOs greedily rubbing their hands together as they approve their own paychecks, and there certainly has been some of that. Others argue that in most cases CEOs are richly compensated because they're so good at what they do.
Several recent studies stake out a middle ground, assuming that CEOs are neither villains nor business masterminds. These studies argue that the seemingly innocuous practice of benchmarking pay against other companies' CEOs may be to blame, because the list of comparable executives is often formed selectively to include highly paid peers and to omit lower-paid ones. Though this opportunistic selection of peers may result in only a small bump to CEO pay in any particular year, over time, the rising tide of peer pay may well account for much of the increase in corner-office salaries that we've seen in recent decades.
If bosses set the salaries of their workers, who decides what the bosses earn? In a modern corporation, the task of setting the CEO's pay falls to the board of directors, typically a subgroup of board members on its compensation committee. A CEO's pay is partly a reward for leading the company and partly an inducement to keep him from leaving for greener pastures.
How much is enough? It makes sense to see what competing firms—the ones that might try to lure your CEO away from his current job—are spending to reward and retain their leaders. That's where the peer-group comparison comes in. But who is the "right" peer? You probably want to pick someone running a company in the same industry, of similar size, of comparable profitability, and with similar experience (similar tenure at the firm and so on). Depending on your industry, however, there might still be dozens of CEOs who meet these criteria—how do you decide who makes your list of comparables?
Compensation committees use their discretion, and that has led to claims of abuse by committees with too-cozy (or just plain incestuous) relations with the CEO. (Compensation consultants, often brought in to help figure out the "right" pay, have also been accused of currying favor with executives in the hope of securing other, more lucrative business from the company.) To shed more light on what had been a less-than-transparent process, the Securities and Exchange Commission mandated in 2006 that companies had to make their peer lists public.
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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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