Unreasonable Compensation

With people focused on the economic downturn, many have found it a good time to give a little extra thought to whether other people are making more than they ought to. The president has spoken out several times against “excessive compensation” of executives, and a number of people have floated the idea of adjusting the top marginal income tax rate to effectively cap total compensation at ten million dollars a year. MZ tackled the question somewhat humorously here.

Beyond question, $10 million is a lot of money. Most of us will never see anything like that much money, and so it seems entirely reasonable to demand: Why should anyone be paid so much? What’s so special about CEOs and actors and baseball players that they deserve tens of millions of dollars? Aren’t they running off with the money that we should be getting instead?

I certainly wouldn’t claim that executives are not often paid more than they are worth. A board of directors is still a group of people with emotional commitments (including wanting to assure themselves that they made the right pick in choosing the current CEO) and they will certainly not always do what is in their own best interest. Though we may be comforted that in a free economy the incentives are in place to automatically punish them for not doing so.

To look at an example of the impact of high executive compensation, I consulted the handy Executive PayWatch Database which my friends at the AFL/CIO put together for me. I picked Hewlett-Packard Company to look at. CEO Mark Hurd made $34,031,021 in total compensation in 2008. This, the AFL/CIO helpfully calculates for me is the same as 836 years worth of salary for the average worker. Should we be outraged?

Well, if we look at Hewlett-Packard’s financial results from 2008, we find that HP had 118.4 billion in gross revenue with 8.3 billion in profits. The CEO’s total compensation is equal to 0.03% of gross revenue, and if his pay were reduced to $100k that would increase profits by 0.41%

If they took the CEO’s pay down to 100k and spread the savings out as raises to all of HP’s 321,000 workers, each worker would make $105.70 more per year: $8 per month.

So is all the money being siphoned off by executives? No.

But why pay them so much? The answer is basically that people get these absurdly high sums of money when they are in a position to affect a lot of money. Brad Pitt makes absurd amounts of money because whether or not he is in a movie can make a difference in $100 million in box office gross. (Or at least, that’s what the studio is betting based on historicals.) Baseball and football players make vast sums because professional sports franchises produce huge amounts of wealth, and the players think that if their playing is what produces all that money, they deserve a decent percentage of it. And CEOs and other highly placed executives make a lot of money because the difference between having a good CEO and a bad CEO can be billions of dollars in revenues and profits. It doesn’t make sense to ask, “What exactly is it that anyone can do that’s worth $130,888 per day?” when it’s not the actions of sitting in meetings, looking at spreadsheets, and talking on conference calls that result in CEO pay being so high. Sure, anyone could sit in those meetings and look at those presentations. However, the difference between a CEO who picks good goals and hires good executives, and one who ignores important opportunities and hires idiots, can be billions of dollars in growth and tens of thousands of jobs.

I don’t deal with C-level executives in my company, but just thinking of the VPs and directors that I have visibility to, there are some who are very, very good — and others that I would happily make a $100/mo paycheck contribution to have fired. The difference between a good or bad executive could be company growth or losses that allow me to get a raise, or cost me my job. And if I care at my level, it’s no surprise that boards of directors care as well.

Now, I think there’s a deeper question here. At a pragmatic level, if a company has to pay $40 million instead of $10 million to get the CEO who will allow them to grow and prosper, that makes sense for them to do in order to make profits for their investors and jobs for their employees. However, there’s a cultural element here as well which we might well question. Who much is it reasonable for a single person to ask for in compensation, even if it is in the interest of the company to offer much more?

I’m of two minds on this. On the one hand, even if it’s of marginal impact to each individual employee, I find myself wanting to say there’s simply a limit to how much personal wealth anyone needs. On the other hand, if that wealth ends up in the hands of one person, it allows him or her to direct the use of that money for good — whether that means founding a school, sending medicines to Africa, or starting yet another company which gives better livelihoods to thousands of people.

However, either way, I don’t see the crusade to limit executive pay by law as a reasonable one. The current system allows companies to pay executives according to the benefit they expect to get from them, and use that money as a motivation to get the executives they think they need. If all CEOs were capped at the same level, that would simply mean that companies would have to find other ways to compete for top talent, and I don’t see how that would be an improvement.

22 Responses to Unreasonable Compensation

  1. Jose says:

    supply and demand, it’s just that simple.

  2. John Henry says:

    Concerns over executive compensations always seem overblown to me; a way for politicians to express faux moral outrage over what is almost entirely a matter of symbolism. In its worst form it exploits a crude populist instinct based on the haunting fear (and resentment) that someone, somewhere might be overpaid. Notice, even if confiscatory taxes were imposed on income over $10 million, the tax would generate very little revenue because the contracts would just be restructured. I suppose there may be some symbolic value in preventing people from being paid large salaries, but it seems to be a very minimal and cheap sort of value.

  3. Anthony says:

    Indeed it is a distraction away from the far more vast and destructive sums being either created or spent by the government.

    While there is something to the argument that top executive are over paid, its really an irrelevant question. They should be paid whatever the market is willing to pay them. If the agreement on compensation is consensual then morally there isn’t much to argue against. If its a stupid move of the part of the employer, that will be revealed in due course as the company’s fortunes decline.

  4. blackadderiv says:

    One of the odd things about executive compensation is that the people who actually have to pay the compensation tend to be the ones who are least concerned about it.

    As for whether it can be justifiable to pay someone $48,000 for an hour’s work, I think that the Wilt Chamberlain example shows pretty clearly that it can.

  5. I’ll point out that to some of the workers on the lower end, $105 extra a year is a big deal (probably an extra week’s groceries).

  6. Matt McDonald says:

    There is a problem with executive compensation. Not that it’s too high, but that it’s unresponsive to the needs of the stakeholders – principally the shareholders of the company. This occurs because of imbalances in corporate governance. I think there are reasonable adjustments that the SEC could make to level the playing field so that shareholders can better control the selection of directors and ensure their interests are better served. This would result in a better correlation between compensation and benefits to the company.

  7. Joe Hargrave says:

    I am opposed to high executive pay not because I think it needs to be re-distributed in a futile attempt at equality (real equality will be established through Distributist principles), but because that much money in the hands of a single individual easily translates into disproportionate political and social power.

    The disproportionate wealth stems from ownership, not work. More evenly balanced ownership, i.e. on the cooperative model, will address the problem. We will see that, after all, it is possible to compete and succeed without paying someone 34 million dollars to make all the big decisions. What a waste of resources.

  8. Joe Hargrave says:

    I also want to add, whenever I’ve looked up CEO compensation, I see a break down that shows, like I said, that almost all the compensation comes from ownership: stock options, etc.

    The actual salary, for instance, of the CEO of Wal-Mart a few years ago was only 1.1 million, but he took home over 20 million in compensation.

    So, I don’t care about 1 million. I don’t think that gives a person a disproportionate political presence, though, if he is a Christian, he doesn’t need that much money and should give a lot of it away. But that’s his decision.

    I do care about the 20 million. Because it places too much power in the hands of one person.

  9. My understanding is that it became a lot less advantageous for companies to give executives stock after the Sarbanes/Oxley round of accounting rules revisions.

    It looks like in this case, the CEO for 1.4M in salary, 5.3M in bonus, 7.9M in stock options and 18.6M in “non equity incentive plan compensation”. So about 1/4 stock, if I’m reading that right.

    It’s really interesting to me (in the sense that it highlights our differences) that you find the stock issues more troubling than the salary. I tend to be very much in favor of paying executives mostly in stock rather than in cash (especially if it’s restricted stock they can’t sell for a certain number of years) in that I think it incents them to look longer term.

    Now for instance, at the company I work for I own about 500 shares total, and my bonus is based on how profitable we are (so it was a lot smaller this year 😦 ). By comparison, the CEO owns a much, much larger percentage of the company. But I generally consider that positive because I hope it means he’s incented to make good long term decisions for the company. The same actions that will make his billion dollar stake in the company be worth 1.5 billion would make my $5,000 stake worth $7,500, and assure me a safe job and good bonuses in the meantime.

    Which basically makes me realize that while I support a democratic (or more properly: representative democracy) ideal when it comes to political structures, I’m basically a monarchist or oligarch when it comes to the corporate world — though I want to see the castes be porous in a meritocratic kind of way.

  10. e says:

    “I do care about the 20 million.”

    Yeah, right.

    Is that only when his stock options are worth that much?

    Would you actually express the same disgust and resentment when his shares are significantly worth less?

    I can’t believe that folks here have the gall to think they can dictate such seemingly draconian terms on companies across America without actually paying any heed whatsoever on the kind of negative repercussions that might likely occur as a result.

    A talented individual such as a Steve Jobs might as well earn a mere dollar/year for his salary, but God forbid that he should happen to be compensated in stock options which value for the most part ultimately depends on his management of the company.

    Should his skillful management of the company be appropriately reflected in the value of those stock options, crucify the bastard!

    Should the value of said stocks fall below a buck, all the better!

  11. Joe Hargrave says:

    “while I support a democratic (or more properly: representative democracy) ideal when it comes to political structures, I’m basically a monarchist or oligarch when it comes to the corporate world”

    And so here’s where we’ll have our disagreements 🙂

    I don’t see how a political democracy can be supported by an economic oligarchy indefinitely. We may call it a political democracy but if real power is distributed differently, it’s just a name.

    What is it people really want in life? I think we agree that no one needs millions of dollars to live a dignified and comfortable life; I should hope we would also agree that any man who says ‘only 30 million can make me happy’ doesn’t have a natural right to it.

    I see no reason why a man can’t be happy with a salary that provides a dignified, comfortable life. I don’t see why progress or economic decision making has to be conditioned on such large compensation. I have a very hard time respecting a person who insists on that much money. What would happen if they didn’t get it? Would they die? What would happen if they just lived at a middle class level, maybe a little higher? It would prevent them from wanting to do a good job?

    I guess I don’t understand how that works. I have many flaws and faults, many sins of which I am guilty, but the need for that much money is something I can say I’ve never had. In fact, give me a computer with an internet connection and I’ll live in a tool shed or a van if I have to 🙂

  12. Joe Hargrave says:

    “Would you actually express the same disgust and resentment when his shares are significantly worth less?”

    Disgust and resentment? You’re projecting your own feelings on to me, E.

    I’m for the stock being more evenly distributed to all of the people whose labor create the wealth that the CEO has been hired to manage. Production is a partnership.

  13. e,

    Don’t be unhinged. No one said what you’re suggesting.

    Joe did say that he finds it easier to approve of cash compensation than stock compensation — which I find myself at variance to — but no one is talking about crucifying anyone.

    (BTW, I don’t think Steve Jobs even gets stock options. He still owned a major chunk of Apple from when he founded it and figured increasing the value of that was enough. As someone who bought Apple stock in 1996, I agree.)

  14. M.Z. says:

    There is a lot to chew on here. I think we are in agreement that the compensation is mostly tied to the performance of the firm rather than the actual work product. My greater concern is not necessarily the gross dollar amounts as much as they act as a first dividend and our lax bankruptcy laws induce companies to undercapitalize thereby resulting in the socialization of risk and the privitization of profit. Similarily companies that carry too much cash on the books place themselves at risk for leveraged buy outs. LBOs wouldn’t be near as advantageous without the bankruptcy protection. Why own company stock if your bonus is equivalent of the dividend of x% of the float? Why worry about the long term health of the company, if you can be paid first and now for risk you aren’t really assuming?

  15. Elaine Krewer says:

    The biggest problem I have with large executive bonuses at failing companies is the fact that the top people who are driving companies into the ground are being rewarded while the people at the bottom who are doing the front-line work, no matter how well they do it, get screwed.

    Take the Chicago Tribune, which is handing out $18 million in bonuses to its top executives while firing about 50 reporters, editors, and photographers. The people who actually make the paper worth reading (or used to, before Sam Zell got ahold of it) get nothing while the people who come up with one harebrained marketing idea after another get rewarded, on the grounds that they are sooo talented that the Trib Company simply must provide them with incentive to stay.

    An insistence on high levels of profit for the benefit of stockholders and executives is a big part of what is destroying the newspaper industry, to which I devoted 20 years of my life. It led to Gatehouse Media — a mega-corporation owned by some mysterious hedge fund in New York — buying up nearly every significant newspaper in downstate Illinois, running up massive amounts of debt, then having to slash and burn the staff at nearly every newspaper it owned.

    Now there’s nothing wrong with making a profit, of course; there’s nothing wrong with making big profits if they are the result of genuine innovation and high demand for your product. If Steve Jobs makes gazillions of bucks because Apple computers are great products and everyone wants one (including me, I love them), I don’t have a problem with that. It’s the idea that you can increase profits SOLELY by making risky investments and cutting costs (which usually translate into massive layoffs) that I have a problem with.

  16. Elaine,

    While it’s a spectrum rather than a duality, it strikes me you basically have high growth business models and sustaining business models. A sustaining business model has the capacity to keep employing everyone well, and if it has investors to provide them with a small return each year. But the business itself is not going to be worth much more in five or ten years than it is now. A great many small family businesses fall in this category. On the other hend, you have high growth business models where you expect the worth of the business in five or ten years to be anywhere from 2-100x what it is now. These are the sorts of businesses which can return a lot to people via stock, etc.

    It strikes me that a number of the problems we have with “corporate raiding” have to do with people who take what is fundamentally a sustaining business model and try to turn it into a high growth business model for a while in order to turn a quick profit. It’s bad for the business, and indeed basically everyone involved except those who cash out early and run.

  17. John Henry says:

    It’s bad for the business, and indeed basically everyone involved except those who cash out early and run.

    The difficulty, though, is that ‘corporate raiding’ is one of the most effective checks we have on agency costs like empire-building (AOL-Timewarner anyone?) and excessive perquisite consumption. Moreover, such ‘raids’ generally benefit shareholders, while the people doing the raiding are assuming much of the risk. LBO’s provide management with a very strong incentive to eliminate inefficiency and produce stable cash returns. I’ll admit that bankruptcy perhaps eliminates too much of the downside risk (as M.Z. suggested), and that some features of these deals are problematic, but here as elsewhere the benefits need to be considered in addition to the drawbacks. And I think LBO’s play an important role in reducing agency costs.

  18. cminor says:

    “I’ll point out that to some of the workers on the lower end, $105 extra a year is a big deal (probably an extra week’s groceries).”

    Indeed. But if I read the post correctly, hiring the cheaper guy could end up in revenue loss for workers.

    When you’re one of the guys on the factory floor who gets laid off because the company’s not being run well, it’s a big deal, all right.

  19. Joe,

    I guess I’d need to think a little more deeply on the topic, but a few thoughts:

    – I’d see democracy as more necessary for a state than for a company because with a state (especially a large, modern state) the potential dangers involved in failure or overthrow much outweigh the greater efficiency one might find in a monarchy or oligarchy. Businesses on the other hand, present fewer problems when they fail. And leaving a badly run company is generally far, far easier than leaving a badly run country.

    – This is kind of an assumption of the above: It seems to me that individual decision making is almost invariably more efficient than collective decision making. Our form of government (representative democracy) recognizes this, in that rather than having everyone vote on everything, we elect people who then make decisions either individually or collectively. While a company of any size is large enough that one person can’t know enough to make all decisions, I do strongly support business models in which each person is the decions maker in regards to his set of responsibilities, with managers making decisions where necessary rather than doing everything by consensus. It’s not as simple as straight top-down management, but like with a well-run army the executives should give the next level of management a clear set of orders and objectives, those managers formulate order and objectives to accomplish those, and so on down the line. Each person down to the individual worker is a creative part of the whole, but each takes direction from above. Given my experiences in various companies I don’t find the idea of true bottom up management very attractive. I guess I should read up on how this works out in reality in organizations like Mondragon.

    – That said, I do strongly believe in profit sharing and employee ownership stakes. I don’t necessarily see why we should require everyone owning the company equally (if the CEO and CFO were the joint founders of the company twenty years before, it makes total sense to me that they’d own far more of it than the 1000th worker hired who’s only been on staff a year) but I do think that everyone should have a real stake in the company they work for. At the same time, my experience is that often the upper levels of management not only make decisions that have wide ranging effects, but they frankly put in more time than most workers would want do. As I’ve started to have to deal with VPs and Directors more, I find myself getting called into meetings that start as early as 7am or run as late as 7pm, and all the executives I know are answering emails and making phone calls in the evenings and through the weekend. 70+ hour weeks seem standard for them — and I’ve got to say that one of the things I’m enjoying about not being in business for myself anymore is not feeling like I need to put in 80 hour weeks.

  20. John Henry,

    Agreed. LBOs are certainly not always a bad thing. Sometimes they turn a failing company into a successful one again. (And as you point out, the leveragers are the ones taking on the risk — since they are “leveraged” as in borrowing the money to fund buying the company on the assumption they can make it work.)

    But at times there do seem to be examples of people taking overweight old companies and trying to turn them into growth monsters when they’re simply in industries where there’s not that much room for growth. (Obviously, the people who try to do this must disagree about whether there’s room for growth.)

    I’d tend to put the fad of buying up regional newspapers around the country over the last ten years in that category. It doesn’t seem to me that there’s much growth potential in regional newspapers these days — at best you can keep them at a sustaining level. Though there are very interesting exceptions. The WSJ has turned itself into a broader national newspaper over the last five years and as a result is growing quite nicely.

  21. largebill says:

    The problem with this issue (like with many others) is it is multi-faceted and people choose to only address the area that fits the point they want to make or demagogue. Class warfare plays well with the masses so politicians make hay about CEO XYZ getting $$$$$$$ in compensation. It is an easy target to shoot at just like complaining about overpaid ballplayers. Truth is salaries at the top have skyrocketed over the last couple decades. However, that truth doesn’t automatically equal all being overpaid or mean that government intervention is necessary or proper to fix the perceived problem. We often hear that a company needed to pay X amount in order to attract top talent. Problem with that argument is it isn’t always top talent (or top results) being rewarded.

    This situation is similar to the problem caused by “free” health care. Whenever the end user is not responsible for the cost of something you can be sure the cost will escalate unchecked. In this case because of the dilution of the strength of the individual stock holder no one is able to speak up about the corporate waste or mismanagement of assets. If a company is owned by one or a few people they tend to be more careful about out of control spending including spending on management. However, a massive corporation has billions of share holders who have little or no say in the level of compensation, perquisites, or golden parachutes offered to management. I am strongly opposed to government interference, but I see it coming because most boards of directors are too cozy with management and are failing to provide proper oversight.

  22. Well said. While some may think $10M or $40M is a lot of money for a CEO there are workers in Africa or China that think making $10 per hour is a lot of money. The goal should not to be to drag down those doing well but to lift up those that are not. You’re free to quit your company if you think the CEO makes too much money. You’re also free to better yourself with FREE books at the library so you can move up the ladder. Besides, the free market will reward and/or punish companies that do stupid things with their money much better than two corrupt politicians being wined and dined by some lobbyist that “help” them decide who gets paid what and who gets taxed and how much.

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