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November 23, 2008

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.

4 Comments (closed)
Tiny Island