Tuesday, 20 March 2018

How do you solve a problem like CEO pay

It's very simple really to most people and that's why its such a complex problem. The problem of executive pay (lets just take CEO pay as a proxy to make it easier to analyse).

For the left, CEOs are greedy bastards who make too much money, when lower level staff in the company can barely make ends meet. Income equality is one the biggest issues facing society. Therefore the answer has to be to curb CEO pay.  Preferably by law. Where is the problem ?

For the right, who is anybody to say what somebody else earns. It's a free market and CEOs perform one of the most difficult jobs of all. When a CEO can increase shareholder value by $10 bn, why should he not get $10 m. Where is the problem ?

In the US, this issue has got into prominence because companies are now required to report how much their Chief Executives make in comparison to the median paid worker. This was opposed tooth and nail by industry, but now the law has come into effect. And the first reports are starting to come in - In Marathon Petroleum it was 935 times, in Del Monte produce it was 1465 times, in Manpower, a temp agency, it was 2483 times. In Berkshire Hathaway it was 2 times.

Governments are starting to act. In the great state of Oregon, where a couple of readers of this blog live, the city of Portland has levied a 10% tax on companies where the ratio is more than 100 times. Many other states and cities are planning a similar levy. I don't think that is right.

Remember, just because something is popular does not make it right. If you held a referendum that the state must burn down the house of every billionaire, it's quite likely to pass with a 75% majority. That won't make it right.

This is not as easy a problem to solve as it seems to the extremists. First to take on the left.

If you extend the same principle to every other domain - no film star should get more than 100 times the salary of an extra. Ditto music star. Ditto sportsman. For that matter why should the mutual fund where your pensions come from, make 100 times more than the janitor who cleans the stock market building. If you sell your property and make a fortune, then of course you shouldn't be doing that as its 100 times more than what the majority of us who have no property to sell are making. We can go on and on. Its been proven time and again  that arbitrary wage equations for everybody will only create a Soviet Union. And why should 100 be some golden number simply because it satisfies somebody's sensibilities.

Now to take on the right. 

Is anybody really worth $98 million ? Really ? That's what Thomas Rutledge took in 2016. The median CEO salary is some $ 11m, but there are also wild outliers. But more than the absolute quantum,  the real problem with executive pay is the reward that even poor performers get. Like golden parachutes if you are sacked. Like pay rises when your company results go down. Like bonuses which don't get returned even though the results are later proved to have been fiddled and overstated. Like backdated stock options. Like saying you have to honour bonus contracts even though your company has just been bailed out by the government.

And then there is certainly the reality that CEO pay has risen far more dramatically in the last 20 years than the pay of others working in the company. It is therefore natural that there is a societal backlash. No society can live with wild inequalities, whatever be the justification.

Companies must be seen to behave sensibly, else regulation is inevitable. A formula could be to more tightly link to company performance, something that's happening anyway. No contractual sweetners that would not be in any other employee's contract. In good years, distribute the bonus pool more widely. Take pay rises only when company performs very well - employees won't grudge your pay rise then. Maybe CEO's can think of contributing 1% to a staff welfare fund. Its all optics. If you not only are fair, but seen to be fair, people won't grudge your pay.

As we began the post, its not an easy problem to solve. So sit back an enjoy how a problem like Maria was solved !


Anne in Salem said...

Reverend Mother solved her Maria problem by sending her away. Should we do that with CEOs?

I don't like the comparison of CEO wages to median worker wage - it's an impossible comparison. Comparing the back-breaking physical labor of a janitor to the cerebral work of a mutual fund manager is not even apples to oranges comparison, it's an apples to chair comparison. Both are working to please entirely different clientele as well - the janitor to please the board of sanitation or a plant manager vs the CEO trying to please the stockholders.

Cutting CEO pay will do less to boost average worker income than assumed. CEOs earn so much in their packages, particularly in stock and stock options, that the actual cash portion is minor. Redistributing the cash portion among all employees won't help them as much as they think. If a CEO forgoes a $5M wage and distributes it among his 25,000 employees, each receives $200. Won't even cover the monthly car payment. Reducing the stock portion of the pay package will do nothing to help the average worker.

I understand the argument of the left. I can't believe any person's work is so important that $50M or $100M compensation package is appropriate. It's obscene. But government regulation is hardly the answer. Government regulation is more likely to complicate a situation than it is to improve it. Attorneys will be the only beneficiaries, charging $500 an hour to help companies avoid regulation.

A crash course in ethics would help the problem. Or maybe the Oracle of Omaha can slap them all upside the head while delivering a lecture on the evils of greed and vanity. But regulation isn't the answer. The ethical CEOs don't need it, and the unethical ones will skirt it however possible.

Yes, not an easy problem to solve.

gils said...

since the ceo gets lots of money they are always the target and rightly so. But what about those at "lesser levels". Why should some techie be paid more than other? End of the day its the value that they bring back to the table and revenue potential is what is the root cause i guess. when similar query was posted to movie heroes who make hay and barn yard and everything while their sun shines, the response was similar. The BO openings are based on their popularity and they bring in the crowds and profits. Above all, shelf life for them is pretty limited. So they earn their loot when its possible. Guess not every CEO is a Zuckerberg in age and by the time they reach that position, they may soon be on the retirement way. But if they can bring in buck for their pay..why not?

Ramesh said...

@Anne - Beautifully articulated comment. I presume the intention behind cutting CEO pay is not so much as to redistribute it to lower paid workers, but prevent a few individuals from undeservedly grabbing a huge fortune. The way forward I see is that remuneration committees of the Board must comprise of strong independent directors who must stab=nd firm on what is right. But not easy at all

@Gils- Yes, its not only the CEO, but many others in a company who should be held to the same standard. I am not with you on movie or music stars justifying very large sums of money on the grounds that they have relatively short careers. The same issues remain. How much is too much. I believe the entertainment industry has a far higher problem of remuneration than the corporate sector.

Anne in Salem said...

Ramesh, I've been considering your response. If the intention behind cutting CEO pay isn't to redistribute it to lower paid workers, what is the intention? Preventing a few from grabbing a huge fortune isn't enough. Solving income inequality requires more than just bringing down the highest; it requires raising the lowest. Redistributing CEO pay would help that, but not much. If not from CEO pay, from where will the money come to raise the wages of the lowest earners? Raising minimum wage helps some but also forces some businesses to close or to pursue automation. Agriculture is turning to less labor-intensive crops or mechanized harvesters to reduce labor costs, like many other industries. That doesn't help income inequality at all.

gils said...

Excellent points by AIS above. I wanted to ask the same thing. If we are saying that the pay for one guy is embarrassingly high, which is a valid call, what we are intending to do with the deducted pay from the ceo's bucket? Robinhoodish share to the rest of employees? plough it back into business? reward the shareholders? my another query is, isnt majority of the money for ceo in form of shares? so typically his salary is based on how much the share increases based on his vision whatever. So end of day if his pay is more wouldnt it have already made his shareholders also richer? that leaves only the foot soldiers as the eligible party to stake claim on the excess loot right..if at all that is correct?

Ramesh said...

@Anne & Gils - As Anne rightfully observed, redistribution will make only a marginal difference. But an important moral point, I believe, is that nobody should be seen as unjustifiably taking advantage (dare I say gaming). Corporate culture is a very important feature of business - if you have a crook at the top, very rarely will the business thrive. If the CEO is seen as purely enriching himself and stuffing everybody else, the company won't survive. It is therefore, I argue, that even if you don't redistribute, the CEO's pay should be seen by others as not outrageous.

Gils - Yes, a fair portion of the rem is in shares. But a lot of jiggery pokery goes on there. Backdated share options, huge discounts at offer price, ridiculous pensions, severance pay - these are what I object to.

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