Reforming CEO Compensation

There’s a lot in the press these days about the irresponsibility of CEOs who lied, covered-up and generally made a lot of cash while destroying billions of dollars of value. For example, here’s something from the Vault’s article on “Are CEO’s Ready To Face Career Instability?“:

As [reviled Lehman Brothers CEO] Richard Fuld’s Congressional testimony aptly underscores, if ever a job requires regular supervision, it is the CEO’s. The risk of a CEO’s poor decisions is socialized across the spectrum of a company … and all levels of workers take the hit when such executives drop the ball. As we see all around us, even strong businesses can be run to the ground in a year….
Gilded nameplates aside, being CEO is still a job. Jobs come with responsibilities, and with the natural expectation that these responsibilities will be fulfilled.
[Emphasis and revilement added]

That’s right: CEO is still just a job. It’s not being a boardmember or a major shareholder. It’s working for someone else.
Elliott Jaques described this succinctly during his work the works council of Glacier Metal Company and with their CEO, Wilfred Brown. CEOs head up a managerial accountability hierarchy. They are the place accountable for all actions in the organization, and should be held accountable by the board of directors, who represent the “association” of shareholders. But this rarely happens, for a variety of reasons.

We’ve let our CEOs run amok, setting their own compensation at 344x the average worker’s while shoveling the coal for the train to hell. Hell for us, that is: they have all made out like robber barons.

It’s time to reign CEOs in. This won’t happen until shareholders, especially major investors like retirement funds, start holding CEOs accountable for having “the courage, determination, discipline, and resource investment that it takes to forego the short-term Wall Street nod in deference to a truly healthy, sustainable organization” (in the words of Michelle Malay Carter).

It will take a major change not in the CEOs but in the boards to whom they are accountable. Directors will have to change their views of what is a good investment, seeing longer term tasks as the job of the CEO. Mark Van Clieaf, of MVC International, has written and spoken extensively on this issue for the governance audience.

The world is once again looking at CEO compensation and accountability, as it did after Enron and Worldcom. Perhaps now we will see a real change for the good.

There are 3 comments .

Jack Fallow — October 21, 2008 @ 8:47 am

Having set senior salaries (or at least advised on them inside companies) it seems to me that there are many pitfalls. It is easy to get the level wrong, just as Mark Van Clieaf has been suggesting.

However, many senior officers never see the output from their strategic interventions. They want to plan for the long term but get measured by fund managers on the quarterly/annual cycle.

So Executives are required to play a game that is driven not by their own the bonus performance but that of actors who are employed by others. ie fund managers. And, because of competition between fund mangers, and the willingness of investors to move to the most recently successful fund manager, each fund manager wants to be top of the WM league tables. So, each fund manager is under pressure to chase the near short term numbers rather than the long term numbers!

I believe ( actually I know) that many folk in banks were aware of the impending doom, but not its timing. However, they had to produce the dividends that their competitors were producing to maintain market share and got involved.

Of course, it can be argued that a good company chairman might help the ‘Wall Street’ folk understand why their particular company is pursuing a different approach. But not many can, and few do with any success. And if they do not produce the dividends…….

So, is this current situation just a set of examples of the natural tensions that exist in capitalism. Energies can shift from satisfying a customer to exploiting an opportunity. Maximising is easily mistaken for optimising. Globalism of communications is mistaken for globalisation of trade and finance. Managers just focus on Economy (level 1)
Efficiency (level 2)
and forget that the whole system requires Effectiveness, Emergence and Evolution.

Or is it just greed?

Reply »

Forrest Christian — October 22, 2008 @ 10:11 am

Greed is always there. You should always design systems to use base emotions to balance base emotions. It helps to keep borderline personalities in check.

There will never be a good answer because long term results must always be in tension with near-term results. It is a delicate tension and not a balance. The problem is that the short-term has overpowered all other ideas.

I think that some of this may be due to the fact that so many people are in the stock markets, at least in America. Our retirements are almost entirely market driven, and many people have investment portfolios.

Tie to this a couple of facts about human nature. As that great philosopher, George Anderson, once said, “losing hurts twice and much as winning feels good.” (Or Prospect Theory, if you like academics.) Then there’s the problem of seeing your neighbor get richer when you don’t. (It also has a cute name which I have forgotten.)

I’m not sure what the solution will be, but it should involve some form of internal checks and balances. Perhaps letting investors choose short or long term, with long-term investors getting subsidy from the government in the form of tax incentives. You need both sides to be powerful and to constantly be battling each other.

The problem for Jaquesians is that the issue isn’t really a problem of the MAH but of the Association of shareholders.

Al Gorman — October 30, 2008 @ 7:49 am

Your point regarding the number of individuals currently invested in the markets is central to the dilemma. If we consider that 80% of the general population possess discretionary time spans less than one year how does a CEO get focused on the long term? Mutual fund managers are pressured to deliver positive quarterly returns quarter after quarter to maintain and increase their fee base. When mutual funds first emerged as an investment vehicle for the masses they had penalty clauses for early withdrawl. This was a deterent to short term liquidation. As the market grew competitors removed these early withdrawal clauses from their portfolios and as a consequence there was no deterent to pulling one’s equity out of the fund. The simple fact is the average investor is not very sophisticated and as a result the markets today are rarely fuelled by fundamentals but run on hype. CEOs as a consequence are forced to stay focused on short term results versus creating longer term value where the short term results would not appear competitve. Warren Buffett would appear to have addressed this by squeezing out many mass investors because of the entry price associated with Berkshire shares. CEOs would appear to understand that their opportunities are limited to the short term and the investor mentality with respect to company executives is you get to eat what you kill thus they seize these short term opportunities to line their own pockets. In order to alter the effectiveness of governance in these companies one needs to alter the perceptions and understanding of the average investor. Good luck! In the meantime executives will continue to exploit the widely held expectations of the average market investor and their fund managers.

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