The Myths of CEO compensation

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I have been having debates with my friends and colleagues for years over executive pay. You, too, have heard me rail that there is no financial or business reason to allow an executive to receive compensation of 100, 200, or 500 times the average pay of the corporation s/he leads. When I was growing up, executive compensation rarely exceeded 10 times the average pay. I realize I am old- but this inflation is not only ridiculous, it’s as dangerous as that obtaining in pre-World War II Germany!

But, this has been the dirty little secret of corporations everywhere. It comes from interlocking directorships and the “good-old-boy” networks that pertain. Companies effect “peer-group” benchmarks. They survey (let’s assume for now they really do the work) similar corporations (by size?  by industry?  by profit margin? – mostly the first, some include the first two, none choose the last) to determine the average pay of executives.  Then, these corporations decide to  pay their executive just a little bit more. It doesn’t take a mental giant to realize that the next survey will find the average pay has risen, and the spiral of ‘compensation increases’  that has resulted from this inane practice. (Oh, I know! If we don’t pay our executives a little bit more, they’ll leave and go elsewhere. Could you please tell me why there is no similar survey, compensation concept, and mental attitude that applies to the workers who make the things the corporation sells????)

Ratio of CEO/Worker Pay

Well, Drs. Charles Elson and Craig Ferrere (both of the Weinberg Center for Corporate Governance at the University of Delaware) published a cogent analysis of the flaws in this concept in an Harvard Review Blog, which they followed up with a full-blown publication.  It turns out that most chief executives (CEO) can’t transfer their skill sets directly from one corporation to another. (Think Meg Whitman, now heading up a disastrous HP, for example.) So, the prevailing wisdom (sic) that ‘if corporations don’t up the executive pay, they’ll jump ship’ just doesn’t fly.

The Elson-Ferrere study determined that most CEO skills are very firm specific. Successful executives certainly leverage their intrinsic talents- and that is why they are chosen in the first place. However, these same executives must rely upon the accumulation of firm-specific knowledge they have developed over their careers.  You know, the old maxim of “organizational memory”. (Notice that corporations in trouble need a different skill-set, those of the ‘turnaround artist’.)

These peer compensation studies don’t take these considerations into account.  Because at their very core they assume that all executives are interchangeable.  Oh, I know I can point to a few folks who break these rules.  John Sculley comes to mind- but he also had (until he fired him) the organizational memory of Steve Jobs at his side.  And, John was replaced again by Steve Jobs (after championing the firm to a rise from $ 800 million to $ 8 billion in size- where Jobs used his extensive skill set (which was amplified by learning new skills at his next 2 companies) and institution memory to grow the company even larger.

It’s about time our corporations understand the study’s major recommendation, that… “…independent and shareholder-conscious compensation committee must develop internally consistent standards of pay based upon the individual nature of the organization.”

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8 thoughts on “The Myths of CEO compensation”

  1. Amen, Roy! It sickens me to watch these ridiculously, high-paid executives come into a company, run it into the ground, and then exit with a hefty severance to boot. I enjoyed your take on John Sculley. Apple was a client of a company I worked for in my corporate days when Sculley was at Apple. It was an interesting time.

    Enjoyed this (per usual), Roy.
    Cathy Miller recently posted..Technical Writing Made Simple, Stupid

    1. Most of these guys (it generally IS guys) have to pay taxes on that income- even if its deferred, when they take it out, they will have to pay taxes. I would prefer that no one gets such multiples- the “wealth” e shared among those folks who help the company deliver the goods or services.

  2. They will continue to be an growing chasm in income between Executives and Laborers. Greed fueled by addiction will often cloud the judgement of many, we have seen a wide range of executives find themselves facing legal troubles for their unethical actions.

    Its difficult to justify the often extreme differences in pay, however without some key innovators many things would not have evolved if their was a more equal playing field.

    Thanks for the article!
    Mike Allan recently posted..Costa Mesa Outpatient Rehab and Addiction Counseling

    1. Mike:
      Thanks for your comment.
      It is not clear that these executives were the innovators that made the difference. I, for one, know that when I was associated with some of these larger companies, they were not even close to understanding the key innovations that were propelling their companies profits. But, many of them were effective leaders- just not worth the pay multiples to which they arrogated themselves.

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