Is there a way to objectively prove the value of CEOs?

Great Debates
1

Questions brought up by the recent salary cap on CEOs of companies receiving bailout money:

  • Does a good CEO make a difference?
  • Does a good CEO make a difference that is worth millions of dollars per year in compensation?

Yes, I know that the market has decided that they are worth millions per year, but is there an objective way to find out whether that valuation is correct?

For example, it is possible that there is some sort of (implicit) collusion among the top-level people who make up the ranks of CEOs and members of boards of directors, so that they pay each other huge salaries. The huge salaries don’t affect the companies that much (since some of these companies make billions per year), so even though it is not optimal, it continues. (BTW: I’m not saying that there is collusion, but just trying to say that just because “the market” decided that CEOs are worth millions, doesn’t mean that it is rational or the optimal level of compensation)

I agree that there are people like Jobs that do make a difference. He brings vision and the attention to detail and form & functionality, and also has a lot of charisma in interacting with the public, journalists and investors, so overall, he has a huge positive impact on the direction Apple takes.

But there aren’t that many Jobs out there.

What got me thinking about this was the performance of all these financial companies that collapsed. The collapse of 100-year-old institutions shows that their CEOs are either idiots or inconsequential to the functioning of the company. In either of those two scenarios, their huge pay is unjustified. Look, you can put a monkey in charge of a 100-year-old institution, and it can easily drive it to the ground, you don’t need a multi-million-dollar CEO to accomplish that.

These CEOs did nothing to stop their companies’ collapse from happening. Most likely they didn’t even see this coming. And, even worse, in many cases their decisions actively led to the downfall.

And these were not some random people. These were CEOs of major corporations. These were people who were paid multiple millions per year because people believed that these CEOs had a huge experience and talent, and would be able to run multi-bilion dollar companies successfully. Obviously, people were wrong about these CEOs.

But what about other CEOs? We don’t always have huge meltdowns to help show the incompetence of CEOs in various industries.

I recall a study a few years back (in one of the financial magazines, like Forbes), where they tried to quantify CEO behavior by comparing the market cap of the company at the end of the CEO’s term with the market cap at the beginning. It’s been a while so I don’t remember the details, but I recall that they showed that the biggest-paid CEOs did not bring the biggest gains for their companies, and in fact many caused their companies’ market cap to drop dramatically.

Of course, one might say, “Well imagine how much the market cap would have dropped without this awesome CEO”, but I think that’s weak. It’s like being tutored by a crappy tutor, and after failing a test, he says “Well imagine how much worse you would have done without me”.

In any case, it seems to me that there is no way to objectively quantify how much of a difference a *particular *CEO makes to a company.

But, the whole financial meltdown fiasco (and of course, the auto industry fiasco) has shown to me that multi-million-dollar CEOs are *not *worth the amounts of money they are paid.

Your thoughts?

  • Is there a way to objectively quantify how much a CEO is worth?

  • Is the current CEO salary level just a bubble that will go away, or is it the proper amount they should be paid because of all that they bring to their companies?

  • Is there any market inefficiency (e.g. some form of collusion) that is allowing these high salaries to continue indefinitely?

  • Has the collapse of many 100-year-old financial mega-corporations due to their actions wrt subprime mortgages, mortgage-backed securities, and credit-default swaps, led you to change how you view/respect highly-paid CEOs of big companies?

2

It’s just capitalism I guess. These guys are paid what the market will bear. I’m not saying I’m in total agreement with the huge salaries, but if company “X” is paying that amount, and so is company “Y” and company “Z” then chances are you’ll have to compensate in the same arena in order to attract at least reasonable competency. We have seen our share of CEOs driving companies into the ground in order to protect their own financial interests too.

Let’s hope it’s a bubble and we can learn to become more like the Japanese.

3

The easiest thing to do would be to try to show that there’s a market failure in CEO salaries. Trying to prove ‘value’ is a tricky thing, but if you can give a plausible reason why the market isn’t setting CEO salaries rationally, then you could build a case from that.

4

Things come in cycles. Companies start off small and nimble, become bloated and inefficient, fire the CEO, a new one comes in and hacks and slashes (and/or splits the company into independent subdivisions) making the company nimble again. Companies become more and more lavish until things start to become ridiculous, and someone new is brought in who hacks and slashes and starts the process over again.

Economic downturns are probably a pretty good catalyst to setting off a spate of cleansing. But for every company that gets caught needing it, there’s going to be a bunch of companies that weren’t in a position of needing it yet. Those don’t make the news.

But as to CEO pay, well the CEO is like any other job. You want to hire someone who has a good track history. Generally that means you want to find someone who’s already got a job as a CEO somewhere else. So you need to make him an offer that’s good enough to make him want to leave his other company. If the need is great enough, the board will go ahead and do that. If it isn’t they’ll get a bit more risky and hire someone from a much smaller company, with less experience, or who headed a division within the company. So there is an amount of balancing in the system. It’s not just an ever-growing bubble. Either the board feels that the pricetag is worth it or they don’t, and if it isn’t they go for the lowest bidder who gives the best interview.

Though like I said, even if there is something of a bubble-ness to it, that’s going to be cyclical. The market can’t afford bubbles, and eventually they pop. Just usually this happens randomly instead of being set off by some outside catalyst all at once.

5

Yes, and Yes, with one big caveat at the end of my post.

What is the inherent difference between WalMart and K-Mart? Or Staples and OfficeMax? Or Best Buy and Circuit City?

It’s not that the successful stores miraculously hired thousands of superior store personnel, it’s because upper management made choices that turned out better than the choices made by the failing stores. CEOs, and the high level managers they choose make a huge difference.
Caveat… Paying millions of dollars per year is no guarantee that you’ll have a good CEO, those failing companies pay big bucks for their CEOs too, look what it got them.

6

A good place to start this discussion might be to actually define what a CEO does…since there seems to be some misunderstanding as to what they are, and what they do:

I get the impression from these kinds of threads that most people think CEO’s just sit around smoking cigars while wearing top hat…or lounging around the golf course all day, when they aren’t off on trips to tropical islands where they are served lobster AND cracked crab on silver trays. Most of the CEO’s I’ve met (and I’ve met quite a few) work 12 to 16 hour days as a norm. Granted, working long hours doesn’t guarantee that they are working smarter, or are doing a good job, and in many cases the CEO is unsuited to the company (or even unsuited for the work).

-XT

7

The next thing to look at (from the same page as the above) would be how to define the success of a CEO:

-XT

8

Bull. It’s collusion. Board members, CEO’s and top shareholders form a network of self interest. ‘The market’ that determines a CEO’s salary is a closed group of friends and acquaintances of that CEO or friends or relatives of someone he went to school with that happened to also pledge at Beta Kappa Fuckstick, or someone who’s married to a CEO of another corporation who also got a large raise last year or someone who owes a favor for getting said person out of a legal jam that one time.

It’s a game of Six Degrees of Separation for success.

9

I agree that there’s a lot of value to a good CEO- everything said in the previous couple of posts is absolutely true.

The problem at many companies is that the higher in the company hierarchy you end up getting, the more the job and your performance tends to be about politics and that sort of thing, and less about your actual performance.

In other words, a guy can have one or two stellar underlings who keep his ass afloat, and if he’s good at the politics, he’ll get promoted up the chain. If his subordinates are moderately competent and his divisions don’t crater, he’ll be a contender for the next level.

This says nothing about the skills of the guy himself… just that he managed to find competent subordinates, or they were there before him.

In my current company, there’s a division that I keep wondering about the vp in charge of that particular division- his underlings are great, but he just doesn’t seem particularly competent to me- I think I’d probably be better at his job than he is, and I don’t even work in that particular division. Sure, he makes money, but that’s because he’s riding a growing trend, not because he’s carved this money out of a limited amount.

10

For an interesting, though admittedly polemic and dated view that is relevant to this, try What do Bosses Do? by Stephen Marglin in the Review of Radical Political Economics, Vol. 6, No. 2, pp. 60-112 (1974).

There were a couple of follow up articles, IIRC. I am sorry, I don’t know where you can get a free copy of this, but I am sure it is somewhere online.

11

Yeah and CEOs are reluctant to fire their presidents. Presidents are reluctant to fire their VPs. VPs are reluctant to fire their directors. Etc.

It’s all collusion man! Oh noes!

But in the real world, it’s not quite that chummy. There are chummy boards, but CEOs are people who are, obviously, business oriented. Being friendly with the CEO of the board you’re on doesn’t mean that you’re not looking at the bottom line at the same time, nor that you’re going to be unwilling to toss the guy to the dogs. Everyone knows what’s at stake and that they’re all pros and peers. There’s not a lot of need to approach it as as much of a boss-employee dynamic. But when the time comes, you can be certain that the board is the boss.

12

Nope. When the time comes, the people who control the information provided to the board are the bosses.

13

The problem doesn’t necessary need to be collusion, just psychology. CEOs are like athletes in many ways. The best of the best make a huge difference in financial outcomes. There are only so many of them, so there is competition to get ones that are thought to be good. But the market has become skewed to expect a certain level of compensation. Every new record contract raises the average expectation. It is a lot easier for a board to approve a 10 million dollar contract when five other boards have already done it. When times are really good, and almost no companies are failing, all CEOs look like geniuses. Perceived success drives up the salaries, and when things go bad, compensation may level off for a while, but it does not tend to go down. So every cycle, the median pay level increases.

Jonathan

14

But even then, the reward for failure in the form of pay-offs is so unutterably immense, millions and millions of dollar/pounds that it to all intents and purposes indemnifies the CEO against failure.

Make an outrageous gamble and you might win big but if you lose you still win big. What incentive therefore to be careful?

It’s Win/Win.

15

No one would want to be the CEO if they weren’t massively bribed into it in the first place. The compensation package is part of that.

16

That’s true. There isn’t anyone who would pick that position over sanitation worker even if CEO didn’t pay multiple thousand times more.

17

It’s not that direct, it’s not like the CEO gets a raise because hes a cutup at meetings. CEO’s compensation and benefits have little relevance to the job he’s doing, that is not a market system.

And Strassia, CEO’s are not like athletes. It is incredibly easy to objectively judge the qualities of walk-on’s in tryouts to see if they have what it takes, you’ll notice there are no political rookies in boardrooms.

18

No one? That’s vastly misleading.

Many people would want to be CEO of, say, IBM, Goldman Sachs, etc, for the prestige.

19

I agree it is not that chummy, but it doesn’t have to be. a lot of directors are CEOs or former CEOs, and since compensation committees base pay on averages, it is to their benefit to raise the pay of the CEO in order to raise their own pay. Baseball players get paid a lot now - imagine what they’d get paid if the people deciding were other baseball players.

Boards do toss out CEOs, but only infrequently, either because of too big to ignore disasters or personality conflicts. The CEO picks the directors, so they aren’t going to be that independent. Sure they are supposed to care about the bottom line, but the election process means they don’t really have to unless someone is making a takeover bid. How many directors have lost elections except in those cases?

20

All this stuff seems to be directed towards CEOs of startups, few of any of whom make tens of millions of bucks. Out here CEOs of startups get plenty of feedback from the VCs on their boards, who care a lot more about the state of the company than the average director, having a lot more skin in the game and often a lot more experience.

CEOs of major companies do get performance reviews, from their boards, but I won’t argue the position that this is fairly meaningless.