CEO Pay: Abomination? Or the efficient market in action?

[msmith537]

@Jackknifed Juggernaut

I think there’s more evidence that you really don’t NEED these. Many entrepreneurs who don’t have any of these do a great job of running their companies. I’m not saying that you don’t need any experience. But I don’t think that what CEO’s are getting paid buys any MORE of these skills. In other words, CEO’s may be getting paid on the belief that they are one of the very few people who can do their job effectively, when in reality, there are many more that can do it just as well (or better).

Nonsense. For every Bill Gates or Michael Dell who creates a billion dollar company, there are thousands of entrepreneurs who create dot-bomb failures. Even for successful entrepreneurs, most only manage to create small little companies that don’t pay out the millions you’re talking about.

And how do I know if someone can actually do it better? I’m not going to hire someone to run my billion dollar company unless they’ve already demonstrated they can run a $500 M company.

@Jackknifed Juggernaut

I think that this is one of those ideas where if you repeat something enough, people will start to believe you. This is the very definition of market inefficiency…where there is a gross misvaluation of a certain asset ( a human asset, in this case). For one thing, you won’t find too many CEO’s who really have good track records. Show me a CEO who has turned around multiple companies. In reality, the most important decision that a CEO can make for his or her own career is to sign with the right company.

I’m sure there are plenty of CEOs who’ve run plenty of successful companies.

[tomndebb]

@Cheesesteak

There are? Who?

Name one person with whom you are willing to entrust a $15 billion corporation with worldwide assets and interests. A person you are going to give the keys to the company, to do with as he deems best.

Who do you choose, the guy who’s doing a great job running a $10 million dollar niche company, or the guy who’s doing a great job as a senior executive at another multi billion dollar international manufacturing company?

. . .

Who do you choose?

I’d probably wander over to Europe to pick up a guy who is already running a company of that size, but who will be delighted to get a pay increase by accepting 1/3 or less of what the current buffoon on the American pay scale is pulling in.

[Voyager]

@msmith537

And how do I know if someone can actually do it better? I’m not going to hire someone to run my billion dollar company unless they’ve already demonstrated they can run a $500 M company.

Bet you would. COOs and other C level execs get hired as CEOs all the time, both by promotion and through hiring from the outside. And there are scads of $500 M companies out there. A hiring committee who can’t find a few good choices is just not doing its duty.

[Cheesesteak]

@Kimstu

Isn’t this hypothetical choice rather artificial? Do corporation boards really have only these two categories of applicants (the CEO of a small corporation vs. a senior exec of one of the top-150 largest corporations) to choose from when picking a new CEO? .

I was responding to J.J.'s claim that you don’t need experience running a “multi-million / billion dollar company” to be the CEO of a huge multinational, and that there are many entrepreneurs who could do just as good a job, or better.

I chose an extreme in order to illustrate that the stakes involved are absolutely enormous, and choosing an expensive guy with a solid executive track record in a big company makes an awful lot of sense over choosing a cheaper wunderkind who’s really tearing it up at a small company. This isn’t like choosing a football head coach, where you can replace him after two years if he sucks, you need some kind of assurance, in advance, that he’s not going to screw everything up, because so many people are counting on the company for their financial security, and so much money is riding on success and failure.
tomndebb, I’d have no objections to selecting someone from another country who has experience comparable to his American counterparts.

[Jackknifed_Juggernaut]

@Cheesesteak

There are? Who?

Name one person with whom you are willing to entrust a $15 billion corporation with worldwide assets and interests. A person you are going to give the keys to the company, to do with as he deems best.

First of all, you’re making a big assumption here. Typically, CEO’s aren’t able to run companies in a dictator-like manner. They usually have teams of managers responsible for making decisions. Additionally, there are policies which state that important decisions must be approved by various committees of the Board, or the entire Board. There are all sorts of “dotted-line” reporting chains. Finally, if a CEO truly had individual responsibility for all management, investment, HR, strategy, etc. decisions, I’d bet that CEO wouldn’t be the current CEO for 99% of companies.

Who do you choose, the guy who’s doing a great job running a $10 million dollar niche company, or the guy who’s doing a great job as a senior executive at another multi billion dollar international manufacturing company?

How do you measure what a “great job” is? I’d say the ultimate measurement is “total shareholder return” relative to the market risk of the company, in comparison to other companies with a similar risk profile. Basically, how much value have you provided to the owners of the company (who have chosen to invest with you, in lieu of a similar company)? I’d love to see some evidence that a CEO has any direct impact on this measure. And I’d also like to see some evidence that a very-highly paid CEO has even a higher correlation. I don’t think that you’ll find any evidence. And factually, a $10 million increase in CEO compensation is $10 million out of the pockets of shareholders (before taxes).

Make a mistake, and millions of people will lose money. Money for retirement, money for their kid’s college, money they entrusted to you, board member, to take care of. Make a mistake, and tens of thousands of people will lose their jobs. Who do you choose?

Again, I’d like to see evidence that highly compensated CEO’s are less prone to make these mistakes. On the contrary, in order to maintain their high compensation, CEO’s have less incentive to make the tougher, but riskier decisions that can truly drive the growth of the company. Basically, they tend to do just enough to not get fired.

[Cheesesteak]

@Jackknifed Juggernaut

Basically, how much value have you provided to the owners of the company (who have chosen to invest with you, in lieu of a similar company)? I’d love to see some evidence that a CEO has any direct impact on this measure.

Lou Gerstner
Carly Fiorina

[Jackknifed_Juggernaut]

@Cheesesteak

Lou Gerstner
Carly Fiorina

I’m guessing that you’re talking about how Gerstner is generally credited with turning IBM around and Fiorina is generally blamed for the demise of HP. It’s impossible to say how much impact these two individuals really had. If they had switched roles, do you really think that HP would have succeeded and IBM would have went down the tubes?

[Cheesesteak]

I can guarantee that a Gerstner-less IBM wouldn’t bear any resemblence to the IBM of today. It was marching down the road of being broken up into Baby Blues, it was Gerstner’s vision that kept the company together and increased focus on providing services, which is a HUGE part of the current company.

I don’t know as much about Fiorina and the Compaq merger, but HP certainly didn’t improve during her watch, and that merger is not considered successful. One would think that a different CEO might have had a different opinion of the merger and might have made different decisions to keep the company competitive.

Whether the companies would be worth more or less is unknown, but they are clearly changed, and massively so, based on who is leading them.

[Jackknifed_Juggernaut]

The primary correlation that we’re trying to prove (or disprove) is whether CEO PAY has any sort of relationship to CEO VALUE (the economic value that the CEO creates for the firm). This is dubious all by itself.

The secondary correlation that we are trying to make is whether INCREMENTAL CEO PAY is related to INCREMENTAL CEO VALUE (relative to a modestly paid CEO). This is even more of a stretch.

And the underlying assumption, which is also debatable, is that CEO VALUE translates into SHAREHOLDER VALUE.

There are all sorts of analyses that confirm and dispute each of these. But in order to justify the extremely high pay of some CEO’s, all of these must be true.

And finally, even if we assume that each of these is true, does a Board of Directors possess the knowledge to even make the correct decision of who the CEO is that deserves the high pay?

[Gangster_Octopus]

@Jackknifed Juggernaut

The primary correlation that we’re trying to prove (or disprove) is whether CEO PAY has any sort of relationship to CEO VALUE (the economic value that the CEO creates for the firm). This is dubious all by itself.

Why’s that?

The secondary correlation that we are trying to make is whether INCREMENTAL CEO PAY is related to INCREMENTAL CEO VALUE (relative to a modestly paid CEO). This is even more of a stretch.

Why’s that?

And the underlying assumption, which is also debatable, is that CEO VALUE translates into SHAREHOLDER VALUE.

Sort of, I guess. I mean there should be some causality, but I am not sure what you mean by “translates”. A company may have a bad year, for many reasons that are not the CEO’s fault. The question is really, does the CEO put the company in a position that gives it the best opportunity to create shareholder value.

There are all sorts of analyses that confirm and dispute each of these.

Can you cite any of them?

But in order to justify the extremely high pay of some CEO’s, all of these must be true.

I agree that CEO pay should be linked to the companies health, but I am not sure I agree with all of your contenetions.

And finally, even if we assume that each of these is true, does a Board of Directors possess the knowledge to even make the correct decision of who the CEO is that deserves the high pay?

The question shouldn’t be do they have the knowledge, because no one has a crystal ball. In every hirig situation you are hiring who you hope will be the best person for the job, but mistakes can and are made all the time.

The real question is not whether or nor Directors have the knowledge to hire what seems to be the best person, but rather do they have the incentive to hire the best person at the proper salary?

[Jackknifed_Juggernaut]

To Gangster Octopus’s "why’s that"s, the answer is simple. There is no reason to believe that this relationship exists. We’ve shown many reasons why many CEO’s are compensated so richly. All of them point to an inefficient marketplace, where it is in the best interest of everyone making CEO pay decisions to increase this pay.

To the second point, when you state that poor performance can occur “for many reasons that are not the CEO’s fault”, I agree. In the same manner, good performance also can have very little to do with the CEO. So, why pay them so much money?

As for cites, there are lots. I can’t find any studies that I’ve analyzed in this regard on the web, but Google will lead you hundreds. And the lion’s share all show that there is no relationship between CEO pay and shareholder return.

http://links.jstor.org/sici?sici=0019-7939(199002)43%3A3<13S%3AEPAFP>2.0.CO%3B2-G&size=LARGE#abstract

http://www.baselinemag.com/article2/0,1540,1990245,00.asp

In reality, there is tons of research available, if you look for it.

To Cheesesteak, pointing out that several CEO’s have had success doesn’t answer the question. Just based on a normal distribution of performance, you’ll always find a few CEO’s who have had multiple successes, those who are 2-3 standard deviations up on the high end of the curve. This is pure luck, or rather, having the good fortune to work for a good company that is in the right markets at the right time. The point is, would the companies have done worse with a lower paid CEO? Probably not.

In general, opponents of high CEO pay will always point to rational, qualititative and quantitaitve reasons why CEO pay is way too high. Proponents always have to seem to point to ideas that can’t be proven such as “the importance of experience” and “former success”. It ends up being a debate similar to the science vs. faith debate.

[Cheesesteak]

@Jackknifed Juggernaut

Just based on a normal distribution of performance, you’ll always find a few CEO’s who have had multiple successes, those who are 2-3 standard deviations up on the high end of the curve. This is pure luck, or rather, having the good fortune to work for a good company that is in the right markets at the right time. The point is, would the companies have done worse with a lower paid CEO? Probably not.

I used to think that a company doing well actually had something to do with the decisions that management makes in directing the company’s actions. Thank you for putting me straight, it’s all luck.

[Jackknifed_Juggernaut]

@Cheesesteak

I used to think that a company doing well actually had something to do with the decisions that management makes in directing the company’s actions. Thank you for putting me straight, it’s all luck.

Who said anything about management in general? Management consists of a group of executives, including the CEO, working together. And of course, management’s decisions have a direct impact on performance. What’s your point?

[Voyager]

@Cheesesteak

I used to think that a company doing well actually had something to do with the decisions that management makes in directing the company’s actions. Thank you for putting me straight, it’s all luck.

The question is whether CEO pay correlates with performance, not whether the search committee should hire by sticking a pin in the phone book. Gertner, coming from another market segment, did great. However Apple hired the CEO of Pepsi, which was a disaster. Carly was not a CEO when she got hired. When I was at AT&T she was not well respected by the masses, and my friends at Lucent were quite happy to see her go. I know lots of people at HP, and they all hated her guts. I don’t think paying her a ton and giving her a plane and a hairdresser did much to make HP a better company.

I suspect that if you analyzed several factors, including success of former company, industry match, culture match, and starting pay, pay would wind up not being correlated the success of a CEO much if at all. One would hope that pay after five years would, but looking at lists of highly paid CEOs it doesn’t look that way.

My suggestion: no salary cap, but tax the hell out of CEO compensation higher than, say, 100 X the median worker salary. Perhaps 100% tax will do, in addition to making the salary and benefits not deductible. This tax goes even if the company loses money - if they’re in such bad shape, they shouldn’t be paying the CEO so much. It might only slow, not stop, salary growth, but one number for the tax bill makes it more transparent, and at least society gets something out of it.

[Cheesesteak]

@Voyager

The question is whether CEO pay correlates with performance, not whether the search committee should hire by sticking a pin in the phone book.

You have to select your CEO somehow. My point was, with so much riding on a good choice, companies are not incented to be tough negotiators on price, while the CEO candidate is probably sitting on a high paying comfortable job to begin with. This puts the candidate in a very strong negotiating position.

I don’t know if CEO pay (without performance based incentive pay) correlates with performance, but I don’t think that’s the only issue. Various questions have been asked so far. Is it an abomination? efficient market? cabal of buddies ensuring their own wealth? rational? irrational?

Ultimately, I think the rate of compensation is based on two parties, negotiating freely, but with one having a significant advantage resulting in a higher rate of pay (and fancy perks like a golden parachute) than one might expect.

I don’t think anything is broken than needs some sort of fix, it’s just a market different than other markets, and nobody is really being hurt. At most the shareholders of the company pay out a cent or two per share, to send a bonus to their new CEO.