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Executive Compensation

I know I haven't been writing much during this period of financial turmoil. That's not because I don't have anything to say, but that I've had so little spare time for blogging. I'm trying to ease back into it.

One of the topics I've been meaning to write about for a while is executive compensation. Outrage over the vast pay packages of corporate executives has been building for years. The government bailout of financial companies has provided another opportunity for people to vent their outrage — or, more honestly, their envy.

Why do I call it envy? Because there's no factual basis for outrage. An individual's pay is a matter between that person and their employer. (In the case of a corporate executive, the Board of Directors represents the interests of the stockholders.) If you're a stockholder and you're upset, you can vote out the Board, or more realistically you can sell your shares — exit being more effective than voice. If you're not a stockholder, what do you care how much money they make? You are not a party to the transaction. It is quite literally none of your business.

What bothers people isn't the level of compensation, but the disparity between the people at the top and those at the bottom. They feel it's unfair for the executives to make five hundred times as much money as the entry-level employees. Feeling doesn't make it so. Running a company takes a lot of hard work and talent and genuinely is beyond the capacity of most people. Competition for skilled executives is fierce, and they have the burden of making incredibly impactful and often risky decisions affecting their employees, customers, and suppliers. They decide which business ventures to expand in, which to cut back on, they evolve the organization of the company, respond to competitive threats, and so on.

If you think the pay is excessive, you're welcome to try to outcompete them. Offer your services as corporate executive for half their salary. See if you can get the job. Think of high executive pay as an opportunity, not as a problem! (But before you try this, you might want to read about Ben and Jerry's experience searching for a CEO when they limited executive compensation.)

It's worth observing that major portions of executive compensation are based on the performance of the company as a whole. Through bonuses based on profitability and stock options whose value swells when the share price rises, it's true that to a significant extent executive compensation can be driven by factors that have less to do with the individual's performance than with the overall economic climate. Stock options do well when the economy does well, and badly when the economy does badly. This is double-edged; an executive who had their options priced two months ago, before the company's value was cut in half, is (almost certainly) not responsible for that fall… but their pocketbook is hurting because of it.

I don't have any specific recommendations about how executive compensation ought to be done. The goal is easily stated: pay should reflect performance. But it's very difficult to measure performance — isolating the executive's impact from the economic and competitive landscape. And it's difficult to structure a pay package so that it provides enough money up-front to motivate the executive to do his job, yet also waits for the data regarding long-term performance to be available.

Until I've served on a compensation committee, or had some other reason to study the intricacies involved, I'm not going to complain much about executive compensation. I know that current pay practices are not ideal, but I don't know how to improve them. I see that executives are making a lot of money and I understand that they ought to. In fact, I'm entirely open to the argument that they're underpaid.

Comments: 4

1: Anonymous
2008-11-24 00:52:47 UTC

You offer Ben and Jerry's as an example. Be honest. Why would a known executive want to work for limited pay when there is an abundance of companies both willing to pay more and to guarantee huge payouts even if the executive fails to perform? Heck, a simple improvement should be to get rid of agreements to pay multiple millions to failed CEOs. Regular folks don't make out like bandits when the screw up on their jobs, why should CEOs?

2: Tom
2008-11-24 14:49:24 UTC

I used to defend CEO pay. But I do not any longer. No sane owner of a privately held company would pay a multi-million dollar bonus to a CEO who oversees the loss of billions of dollars and bankrupts a company. In fact I believe there is a fundamental flaw in the way CEOs are compensated in public companies. Incestuous relationships between the compensation committee and the CEO. Publicly held companies appear to run for the benefit of the management not the owners. Since these are publicly held companies, which are regulated in many aspects, why not add an additional regulation and require full disclosure of executive pay and other highly compensated employees. Then let the owners, the shareholders, approve the pay of the top 10 percent of the highest compensated executives and employees.

3: Din Lloyd
2008-11-28 19:23:50 UTC

"... The goal is easily stated: pay should reflect performance..."

Not at all. Compensation should be designed to attract and retain the CEO that is expected to maximize the net return for shareholders.

Since future company performance is so highly variable and uncertain with respect to a CEO choice, it is almost inconceivable that the highest ranked candidate should be allowed to escape to a comparable competitor for compensation reasons alone.

Regards, Don

4: Anonymous
2008-12-08 05:11:59 UTC

i agree it's none of my business... unless of course they are one of the seemingly endless supply of executives "asking" (and when i say "asking" i mean "asking my 'representative', who will then _not_ ask me personally) for money out of my wallet. Incidentally, when i say my "representative" i mean "the person who claims to be my representative in the U.S. Conrgress, by virtue of an election in which my individual vote made absolutely zero difference."

Anyway, if you can't manage your balance sheet, and have to ask the government for help, and resort to ridiculous "frogs and fish will rain from the sky" stories of what will happen if you don't get it... then yes, it is my business what you are paid, because ultimately I am going to be paying for your mistakes and/or your actual paycheck.

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