Focus: Executive pay and performance

http://www.economist.com/blogs/graphicdetail/2012/02/focus-0?fsrc=scn/tw/te/dc/executivepayandperformance

by stfu • 14 years ago

76 86 14 years ago

tocomment• 14 years ago

I wonder if they would find a correlation between board members not getting voted out and CEO pay. Maybe shareholders tend to be pleased if boards hire big name CEO's?

wisty4• 14 years ago

Or CEOs who wow the shareholders get rewarded by board members?

jtbigwoo2• 14 years ago

Many companies have what basically amounts to a board exchange where a high-ranking official from company A serves on the board of company B which has an official on company C's board and company C has an official on company A's board. In the end, it has the potential to be an "I'll scratch your back, you scratch mine" arrangement.

talmand2• 14 years ago

And this is a surprise? I didn't need research to determine this, I just kept up with the news.

scott_s3• 14 years ago

http://lesswrong.com/lw/im/hindsight_devalues_science/

talmand2• 14 years ago

It's not hindsight as I'm reading the news article that day.

vsl2• 14 years ago

Conflict of interest where the CEO (or his friends on the board) decide how much to pay him? Say it isn't so.

jbooth9• 14 years ago

I really don't understand why people think any amount of pay over, say, a few million, for any position, makes any difference to anyone.

Think about the people you know who are good at their job. Do they give a fuck about money if you give them enough that they're taken care of? No, they probably care a lot more about prestige, interesting problems, other ego-feeders besides a silly 8-digit number.

Of course, CEOs are bound to be good negotiators and will negotiate themselves a higher number because why not. But is anyone going to argue that there's a serious quality of life difference between 20 and 100 million?

cynicalkane3• 14 years ago

Like almost every software engineer, I get paid far less than a few million dollars. And like almost every software engineer (the bachelors, anyway) I get paid far more than I "need". But according to many HN articles, if I were to accept a job without negotiating my pay upward as much as is reasonable, I would be a sucker.

TBH, if I heard a CEO of a for-profit didn't try to get a higher pay package, I'd be wondering about this CEO's business skill.

starwed• 14 years ago

>TBH, if I heard a CEO of a for-profit didn't try to get a higher pay package, I'd be wondering about this CEO's business skill.

That's because you, like all people, suck at thinking rationally.

jbooth9• 14 years ago

Of course he's gonna negotiate upwards. Someone good at the job of CEO would do so instinctively, because negotiating is a big part of their job and they like to do it well.

But it's not what his performance or his quality of life is based on.

lambersley• 14 years ago

The fault isn't being placed on the CEO. He is an individual who seeks personal gain primarily, places family interest and other similar motivators ahead of the needs of the organization he leads.

Rather, fingers should be pointed at Boards who agree to ridiculous compensation packages.

wisty4• 14 years ago

Most economists say that every good is non-satiable, except money, which people only want for the purpose of consuming goods.

In reality, the reverse is often true. You can have too much pizza (though it can be fun to try). You can't have too much in your bank account (or investment portfolio).

bartonfink• 14 years ago

True, you can't have too much, but you can have enough that it puts you well past the point of diminishing returns.

If I, for example, were making 1m a year as a software engineer but still had to answer to someone else and deal with bullshit (read anything I didn't want to deal with - politics, TPS reports, writing boring software, limits on vacation), I'd still be as unhappy as I would be at twice the pay. More money wouldn't make the situation any more palatable. Getting a position that lessened the bullshit would. That position could take several forms, and there's many different levers (e.g. paid vacation, a position of substantial autonomy) I can pull besides money to increase my satisfaction.

I can't imagine, though, that most CEO's can move those levers drastically. It's not like you can negotiate for a more reasonable board come hiring time. CEO's don't take vacation in the same way you and I do, and even if they did, I'm not sure a CEO who fought to take time away from his company would be thought of favorably.

twoodfin• 14 years ago

> You can have too much pizza...

But you can't have the best pizza in the world without potentially spending thousands of dollars to get yourself to Naples.

That's an extreme example, but I assume those economists mean that almost any category of good can reach arbitrary levels of consumption. If I had several billion dollars, my pizza acquisition budget might literally be 1000x what it is now.

JumpCrisscross6• 14 years ago

Because I want to have enough money to say hey, people should go to Mars and so I'll start a company that does that. I want to pursue social, medical research, and technological policy on my own terms which needs my own capital.

Because I want that apartment on One Central Park that costs $17 million and I want a chauffeur at 50k a year and a PA at 100k a year and someone to take care of my kids for 100k a year (no sketchies). I also want to be able to hire a plane when I want to do I can zoom out to Tripoli or Nigeria when interesting things happen and no private charter will go.

Maybe I'm being the stereotypical New Yorker, but I can see 30, 50, even 100 million dollars whisking away rather fast. You know what traders call $100 million of personal income? A unit. It's the starting point.

Note: CEO pay is not, when done sensibly, where the Board goes "Mark, you look damn handsome today - here is a hundred million. Go wild." It is a structured pay where you try and align incentives, that is, give the CEO upside when he does well and some downside when he doesn't. You want to encourage sensible risk-taking, remove principal-agent issues, and deal with moral hazard. Most pay for CEOs comes in stock grants or via other non-cash instruments. It is also usually not guaranteed up front.

michaelochurch4• 14 years ago

So are you a douche, a douche sympathizer, or being ironic? Inquiring minds want to know.

CEO pay in Fortune 500s is upper-class back-scratching. Nothing more. It has nothing to do with performance.

jbooth9• 14 years ago

So, corporations should pay CEOs bigger salaries, because it's the most effective way to boost human space travel?

This is the highest voted counter-argument?

MaxGabriel• 14 years ago

This video cites several studies showing just that: beyond a certain threshold, money does not improve performance

http://www.youtube.com/watch?v=u6XAPnuFjJc

byrneseyeview6• 14 years ago

Past a few million, wealth has basically no correlation with consumption. So to the extent that economic inequality is about unequal access to consumer goods (vs unequal numbers in a brokerage account), those high incomes are not a factor.

But they have an important indirect impact: wealth correlates with power; if you're richer, you can control more businesses, and run them the way you'd like. Thus, high marginal income taxes keep the old guard in power longer, and mean that ambitious people with new ideas take longer to take control.

High income taxes and capital gains taxes will mean that proportionately more of the world's companies will be owned and run by Rockefellers and du Ponts rather than Zuckerbergs.

jbooth9• 14 years ago

Nobody's talking about taxes here, and your assertions are completely unfounded. Save it for meet the press.

CWuestefeld3• 14 years ago

But is anyone going to argue that there's a serious quality of life difference between 20 and 100 million?

You're only looking at it from the executive's POV, not the company's. They are looking for the best they can find. It may be worth it to them to pay, $X million more for somebody who scores a 99 on a hypothetical CEO test, compared to somebody who scores only 98. The company wants to get somebody better, and to get that higher quality, they've got to fork over additional compensation.

Of course, companies are frequently wrong in the way that they score their candidates. But that doesn't change the fact that they've bidding on the highest perceived quality.

jbooth9• 14 years ago

I am in fact looking at it from the company's point of view.

Anybody who doesn't want the job enough to do it for 10 million but would do it for 100 million is going to SUCK at the job. Period.

scott_s3• 14 years ago

Michael Lewis points out in one of his books that for people on Wall Street, income is just a way of keeping score - which implies that money still is an incentive, just that the reasons change.

vannevar7• 14 years ago

This actually implies that they don't really care about the money, only about the relative 'score'. Which means that they would not be disincentivized by heavy taxes, since their before-tax score is what matters to them.

cynicalkane3• 14 years ago

The headline is probably true in the statistical sense. The sample size is undoubtedly small and economic data are often tainted by the efficiency effect--the 'experiment' is uncontrolled and actors might already be choosing the results that are best for them, dramatically reducing the apparent statistical effects of their decisions. Finally, CEO pay is often negotiated before performance becomes apparent, and for something like CEO I'd imagine it's really hard to tell how well they'll do in advance, even if you're trying to pick the best people for the job. It's not like there's a CEO aptitude test, it's not like the skills picked up being CEO of Pepsi are necessarily transferable to being CEO of Apple Computer (for example).

The headline might also be true in the economic sense. I'm not especially qualified to judge this.

The article, however, is quoting the apparently private data of one obscure financial research firm. So I'm filing it under Not News.

(I also just noticed that they call Warren Buffet 'underpaid'. The guy earned fifty billion dollars being CEO of Berkshire Hathaway. Calling him 'underpaid' seems like a bit of a technicality.)

JumpCrisscross6• 14 years ago

I think the point is the board should structure pay so that when the company does well the CEO automatically earns more and when it doesn't he doesn't.

cynicalkane3• 14 years ago

CEO pay is frequently structured like this already. CEOs will often get half or more of their pay in restricted stock and options, and it's not unheard of for their salary to be a token value like $100 or $1. They also have the incentive of not being fired, and being re-signed if they're on contract.

The alleged problem is that the vesting/restriction periods for these stock and options is too short, like a few years. I have a pet idea that CEO pay should be mostly in stock that vests quickly but is restricted for a very long mean time, like 20 years. But that's just a pet idea and I bet it would be a very hard sell to potential CEOs.

I also think pay for performance is overrated. It won't help if you have the wrong guy in the first place.

brianlouisw• 14 years ago

Paying CEOs for 'performance' may not be a significant improvement unfortunately.

Daniel Kahneman, and Nassim Taleb have spoken about this - essentially that there's no good reason to think CEOs of large companys have any significant control over their company's outcomes. Our judgement is clouded by a combination of hindsight and narrative biases along with a significant underestimation of 'luck'. Kahneman quotes something like a .6 correlation IIRC. So, it CEO performance exists, it's just overestimated.

Kahneman's new book - Thinking Fast and Slow - is an excellent read.

http://www.smh.com.au/opinion/in-dumb-luck-we-can-trust-2012...

thelonecabbage2• 14 years ago

And how would the company have performed if they hired a less expensive CEO?

Fantanomics.

outside1234• 14 years ago

i don't know how you could possibly say Steve Ballmer is underpaid for his performance.

forgotAgain5• 14 years ago

It's interesting that the cause for spiraling CEOs salary is similar to the cause of spiraling Civil Service salaries over the past 30 years. In both cases compensation is not based on performance but rather on what others in similar positions are receiving and control of the compensation process.

In corporations there will be board compensation committees that hire outside compensation consultants. The consultants will come back with a suggested salary that is the current standard for similar companies plus an additional amount to insure that they "get the best". There are only a small group of such consulting companies and it is in their self interest to inflate executive salaries. Suggesting lower salaries would mean a loss of future business because it is the very same executives that hire them.

For civil service contracts their will be independent government boards set up to negotiate salaries. To insure that the boards are independent they are usually constituted using a political process. As a baseline for salaries they will use formulas based on what other unions make plus a little something extra because "well everyone deserves a raise". As with the executive compensation committee, it is in the self interest of the government compensation boards to be generous. The government boards are appointed positions based on the party in power. Given the capabilities of unions in voter organization, it is fair to say that they at least indirectly hire the compensation board members.

The net result in both cases is spiraling salaries that have no relation to performance.

api• 14 years ago

The right likes to scream about this phenomenon in civil service. The left likes to scream about it in the private sector.

Incredibly good point... it's the same phenomenon.

We need -- collectively -- in all spheres -- to take a good look at some people and start asking questions like "what exactly is it that you do here? what value do you create that is commensurate with your salary?"

In government this has to happen at the management or political level. In the private sector this needs to happen via shareholder pressure. If shareholders had a brain, they would start agitating for long-term merit-based CEO pay.

maratd2• 14 years ago

The best solution, in both the government and private sector, is to keep things small. Smaller governments and smaller companies.

On the small scale, it's very easy to ask "what exactly is it that you do here?" to everyone involved in the entity.

gph• 14 years ago

Ah, but not all shareholders are in it for long-term gain, so they don't necessarily want a CEO that aims for the long-term. And even those that are technically in it for the long-term are hand their money off to Fund Managers, who as recent times have shown aren't that great at long-term investment either.

jbooth9• 14 years ago

I think you need to be a lot more specific in what you're talking about with regard to civil service salaries.

I've actually been on municipal boards negotiating with unions and the salaries definitely were not going up more than inflation. But the amount we were spending on employees was in fact skyrocketing.

You know why? Health insurance. Any study showing you one number and omitting the fact that none of that increase actually goes into employees' pockets is lying to you.

kbutler• 14 years ago

Add non-profits to this list. The same mechanisms are in place, and executive compensation in non-profits is routinely compared to that in "a company of similar size".

vannevar7• 14 years ago

Except that civil service salaries haven't been spiraling at all. Since 1969 they've gone up 428%, yet the consumer price index has risen 477%. See http://assets.opencrs.com/rpts/94-971_20100120.pdf .

Meanwhile CEO compensation has more than quadrupled just since 1989. See http://www.forbes.com/lists/2011/12/ceo-pay-20-year-historic... .

forgotAgain5• 14 years ago

The public payroll information for my state is available through the website http://seethroughny.net/. For 2010 there were over 116,000 public employees who made $100k.

dustingetz2• 14 years ago

my gut reaction was "so what?" the article doesn't attempt to explain. why does this stat matter?

michaelochurch4• 14 years ago

It's actually a steep negative correlation if you take a historical context. In the 1970s, CEO pay was much lower and companies were well run. Now, CEO pay is very high and the results are awful. I explained this "paradox" in a blog post a year and a half ago:

http://michaelochurch.wordpress.com/2010/11/22/pay-more-get-...

thelonecabbage2• 14 years ago

They also wore more hats. Or the market was different, or they weren't dealing with labor shortages, or their predecessors set the stage differently, or inflation has increased 580% since 1970....

It's not possible to tease out the cause and effect.

Fortunately there is an easier way to figure it out; if the businesses are hiring idiots, at far to much money the easy way to tell they are doing it is their stock price will plummet and they will go out of business.

masklinn• 14 years ago

> or inflation has increased 580% since 1970....

It also has increased for workers, and most comparisons (including Michael's) look at the ratio between top executive comp and average worker comp.

CWuestefeld3• 14 years ago

Or the market was different, or they...

A really significant difference that I rarely see acknowledged in these discussions is that the means of compensation has changed drastically in the last few decades.

It used to be that executives got part of their compensation through perks like generous expense accounts, or country club memberships, or keys to the executive washroom. Changes in tax laws and other cultural norms have eliminated these as such. But the corporations still need to be able to compete for the same pool of executives, and so the money that had been going into those perks now surfaces as monetary compensation.

In other words, much of the apparent increase in salaries is actually just that part of the old-days compensation wasn't reflected as income.

jgmmo• 14 years ago

"In the 1970s, CEO pay was much lower and companies were well run. Now, CEO pay is very high and the results are awful."<citation needed>

How can you possibly make the assumption that companies are run worse today than 70's? What quantitative measurements show this 'steep negative correlation'?

dustingetz2• 14 years ago

wow dude, that's quite cynical, and subjective at best. Go look one of these "parasites" in the eye and tell him that you think he's a "psychopathic narcissists ... influence-peddling assholes" and that he's not "selfless, enlightened, pragmatic".

TLDR: if there was any weight to your thesis (which is, what, exactly?), you totally discredited yourself with your cynicism.

Gustomaximus• 14 years ago

I recall a study some years back on Australian CEO's of public companies and they found a negative relationship between pay and company performance.

I tried to find the article to no avail. This article says no relationship between pay/performance but mentions many previous studies have found a negative correlation: http://www.sef.hku.hk/upload/faculty/42/officer-remuneration...

byrneseyeview6• 14 years ago

Zero correlation is a surprising number. That seems to imply that CEOs are paid fairly; I had thought they were overpaid.

If they're underpaid, there should be a positive correlation between CEO pay and corporate performance (i.e. the companies that pay the most can hire the best people). If they're overpaid, there should be an inverse correlation (i.e. the companies that pay the most are likely to overpay the most, and thus waste the most money). So the exact middle ground implies--the exact middle ground. I didn't realize the market was so efficient.

The other possibility is that CEO pay or market performance are totally random. But all you need to do is identify a few very effective and very well-paid CEOs to argue that this is false. Just look at e.g. JCP's new CEO (they nabbed him from Apple thanks to, in part, a generous options package).

This might be clearer in another context: it wouldn't surprise me to find out that your average hunger in a given day has no correlation to your daily caloric intake. That wouldn't imply that calories don't satiate hunger; it would imply that most of us eat something close to our daily calorie requirement.

stdbrouw• 14 years ago

Even for very highly paid CEOs, you wouldn't expect their remuneration to be much more than a single percent of revenues, and so underperformance as a direct result of overpaying the CEO is unlikely to be an issue for any big company.

Statistically, the direct effect of CEO pay on the bottom line is dwarfed by the indirect effect of his/her work on the bottom line, making it hard if not impossible to isolate, and so I don't think these numbers quite tell the story you think they do.

monkeyfacebag2• 14 years ago

> all you need to do is identify a few very effective and very well-paid CEOs to argue that this is false

No. If there's no correlation between CEO-pay and performance/market cap, finding a few interesting counter-cases doesn't further your argument. Inherent randomness and lack of accounting for other factors are far more likely to be the culprits here than market efficiency.

EDIT: Further, zero correlation isn't a "middle-ground" between positive and negative correlation. If it implies anything it's that one variable (performance/market cap) doesn't depend on another. If there's no correlation, CEOs can still be overpaid, they just can't do worse for their companies as pay increases.

byrneseyeview6• 14 years ago

I'm presenting two possibilities:

1. There's an efficient market, and CEO pay reflects the extra value they create. In other words, a $100 million CEO is worth $50 million more than a $50 million CEO, so your economic outcome is the same regardless of which one you hire--except that larger companies will extract more value out of a given level of managerial talent, since they can amortize it over more underlings/revenue/whatever.

2. CEO pay and company performance are totally random. But for that to be the case, you'd have to deny that there's any such thing as being able to identify and pay for a talented CEO. Maybe! But every time I've interacted with large company CEOs, I've noticed that they tend to be very bright, and they work extremely hard. People who are in the 10th percentile of public company CEOs--the kinds of people who bankrupt companies--still seem to be in about the 90th percentile of smarts and energy.

I don't know of another theory that could explain the data as presented. Either the process is random, or it selects for people with certain valuable skills. If the system tends to promote skilled people, you'd expect the companies they run to have a higher return. Unless, of course, they capture that value for themselves.

JoachimSchipper• 14 years ago

This seems unlikely. JCP's CEO apparently gets ~.5%-1% of JCP's profits (i.e. ~.01-.02% of revenues, dependent on performance). 0.01% of revenues is not enough that a company will actually feel the CEO's salary, but it seems very likely that a marginally better CEO can raise profits by 0.01% of revenues (which would allow a doubled base salary!)

More likely explanations: various inefficiencies interfere with getting the best, (good) CEOs are not easily attracted by even larger salaries, companies in dire straits need to pay for the damage they're likely to do to a CEO's resume, the study is simply too small. (Teasing out a 0.01% effect is hard!)

polyfractal• 14 years ago

There is an interesting podcast with Steven Kaplan about the same issue. His research showed a similar result: CEOs are paid fairly and have had wage growth similar to other highly skilled fields (doctors, lawyers, etc).

Conversely, he found that hedge fund managers have absolutely skyrocketed past everyone else. They have totally blown past any type of normal wage growth and are the real culprit for the "1%" phenomenon.

http://www.econtalk.org/archives/2011/11/kaplan_on_the_i.htm...

7952• 14 years ago

I would love to know the break down by type of business. Surely a CEO is more important at a product lead company than a service company?

verelo• 14 years ago

This makes me think back to the TED talk that discusses that higher pay actually decreased performance and employee motivation when innovation is required.

Interesting that the overpaid industries are those that i would consider to be less innovative and those that are considered underpaid are the move innovative industries and companies. That is just my opinion however.

http://blog.ted.com/2009/08/24/the_surprising/

Focus: Executive pay and performance

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