If their pay is strictly related to performance, what incentive do they have to take risks, which yield the largest returns (both for shareholders, and for all of humanity)?
Pay related to performance still rewards risk-taking, just as long as they are smart risks, where the likely benefits outway the negatives.
Let’s look at it this way. There’s the company. It hates risks. Not everyone has cushy bonuses waiting for them, including the people that are there to implement a CEO’s crazy-stupid plans, assuming such plans exist. But then there’s shareholders. They love risk. They’re diversified; if one company falls, well, that’s life, they’re invested in other industries etc. But if this company takes off, they stand to make a killing. Both of these interests pull at a well-run company. How do you suppose we balance these two interests? I’m assuming that a CEO who might lose his house if the company folds is not going to take the risks shareholders want. Perhaps you wouldn’t make this assumption.
Um, share value folds. Not the company itself, though that would be included.
I suspect that most executive decisions don’t boil down to mean and variance. That is, some investments are pure wealth-destroyers, in a way that can be anticipated ahead of time.
That said, shareholders love diversifiable, idiosyncratic risk: they don’t like market risk so much. In financial parlance, you want CEOs to enhance their alphas and reduce their betas. One method of doing this would be for them to set aside some cash in escrow for stock buybacks when the market declines – and not merely the individual stock. I’m not aware of this ever happening.
I might speculate that if you pay an executive a cool million per year in cash, then his escrowed heavily restricted stock might be treated as an elaborate score-keeping device.
I guess I’m dodging the issue though. Do you want to give a CEO the choice of betting his house on the company, all the better for him to keep a careful eye on its long term prospects? I was assuming yes, but I really don’t know.
New thought: we’re going to have to experiment. So any proposed incentive plan could probably use some improvement a decade later.
Are we in rough agreement that there is, in fact, too much risk in public companies? If public companies were forced into far less risky ventures, would this be a boon for society, or just for private firms?
The comparison you draw concerning the President’s 27.6x multiple of the lowest paid full time workers in America isn’t an unreasonable multiple though higher than I would like. But, in the present crises, we aren’t talking about CEOs whose annual salary was a mere $400K and we aren’t talking about CEO pay multiples of 27.6x nor are we talking about people making $7.50 hour until we get to rock bottom. In my experience there are damn few minimum wage workers who invest in stock or in any savings plan whatever simply because they need every nickel they get just to survive and barely at that. And, just for the record, there are any number of minimum wage workers who do not work full time but who are limited to part time hours in order that employers be not required to provide benefits. The denial of benefits to employees does nothing more or less than to increase the money available to provide benefits to the CEOs and executive staffs; I am confident that their health care and retirement benefits are not reduced or eliminated. Basically, I think the BS concerning the President and minimum wage workers is nothing but smoke and mirrors. And in the case of the President who has presided over the last eight years, we damn sure should reduce his pay to maybe minimum wage and deny him his pension. He has done nothing to earn his pay or his pension.
I don’t know that there’s too much risk, but there are bad incentives. If a CEO’s level of compensation is driven by the current stock price of the corporation he’s running, it gives him the incentive to take actions that are destructive in the long term to create gains in the short term. If executives are shielded from liability for making bad business decisions that cause the company to collapse and are shielded from personal consequence by golden parachutes and buyout packages, then they have an incentive to take huge risks for huge payoffs.
This excellent post bears repeating. One of the most frustrating things about the Dope is that any idiot google boy can argue in circles for 10 pages while a real expert who offers up an intelligent opinion can be drowned out by the neverending nitpicking.
Please pay attention folks. Algher clearly knows what s/he’s talking about.
I have also underlined what I believe is the relevant point here – and one which appears to be lost on most of the participants of this thread.
I liked Algher’s posts, too.
Could I offer another version of his underlined sentence? Instead of using the words ‘…they will find a way around it…’ which has the potential to conjure up all sorts of assumptions of evil, negative intent, how about
‘…the market will always attempt to equilibrate supply and demand, even in the face of regulation.’
I’m sorry, are these bad incentives or too much of good incentives?
Well, if he’d like to be known as President Don Quixote Bozo Obama, he should come right out of the box arguing for something as naive and communist as a Federal law imposing arbitrary salary caps for executive pay.
And it might even play well to the oppressed polloi, out of the box. Even the execs might go for it; the great thing about such a simplistic approach is that it’s so easy to get around laws so simplistic they are stupid. What you don’t want as if you are a greedy and unprincipled executive is some sort of more reasoned and fundamental regulatory change that actually levels the power playing field of who gets to decide your compensation in the first place.
Perhaps first to fall under the new pay cap law’s embrace would be an assortment of Hollywood stars suddenly bummed they voted for Mr Obama: “Umm…the new payscale is $200,000/movie; not $10 million, Mr. Clooney.” NBA: you are next.
The system is unfair to the little people? Let’s just pass a law to make big people smaller. Done. Hmm…what to do in my second hundred days…
Sorry. GOOD incentives for executives, BAD incentives for shareholders and society.
Are you suggesting that our duly elected representatives accept bribes? If not, just what are you suggesting?
Speaking as the OP, I’m wavering on my stated position, thanks to a couple of posters in this thread. I still believe CEO pay should be capped but I’m uncertain as to how it should be done. And I will admit that my range of caps is probably too low, so I’m rethinking that as well.
Anyway, thanks to everyone who has posted so far.
Risks? Hell most of them were bankers. The money they were risking was ours. I do not want banks risking the money on adventuresome deals. Whatever they took in they gambled with because they killed the margins. They were supposed to keep a big portion to retain solvency. They got the rules changed. Thanks to Gramm for a big part of that and the regulators for the rest.
Tying compensation to performance includes having the same incentive for great compensation associated with the risks. This is in contrast to the current system in which there is no risk for the CEO with his golden parachute and the musical chairs the CEOs play around the executive suites (without removing a chair/suite when the music stops). Give them decent compensation (not the obscene stuff they get now) for brilliant gains and let them join us stockholders in their risk-taking.
Not that I think this matter is easily settled, but I don’t agree. Making a no-documentation loan isn’t really a matter of risk, just a failure of due diligence. There is no explosive upside to such policies, from society’s perspective. Rather, the loan provider can make a quick buck, provided they are able to palm off the mortgage on somebody else.
In pharm and R&D intensive industries, I can imagine that risk does matter. In that context, it would might be better for the firms to spend more on R&D, given that it has wider societal benefits that the firm can’t capture. So risk is part of the story, but I would guess not most of it.
I’m personally not upset about golden parachutes. The incentives may be misaligned, but that doesn’t mean they’re wrong. A CEO should have a healthy view of risk different from someone who is only personally invested in the fate of a company.
Take pharmaceuticals. Pharmaceutical start-ups happen when some group of chemists get an idea they are fairly sure will work. They create a start-up with venture capital funds to develop an idea with the intention, usually, of their company being swallowed up by a larger company when (if) it pans out. If all public companies became risk-averse, it wouldn’t eliminate risk, it would hide it in venture capital to an even greater degree than it already is.
If the incentives aren’t tweaked right, then they’re not tweaked right, but I am far form convinced that they’re wrong, or that eliminating golden parachutes represents a solution to what may be a non-problem.
This is a small point, but I like, “They will find a way around it.” Sure you can pass laws, but specialists will always think through potential ways of circumventing them. Affected parties are resourceful.
It’s not really about supply and demand so much as a property of regulation and law. As erislover points out, it’s not like there’s an open auction market on CEOs – this is a matter of negotiation, not arms-length exchange.