Stuffing Their Pockets (For America's CEOs, a very lucrative recession)

Newsweek ^ | 09/06/2010 | Rana Foroohar

[expat_panama]

What do the stockholders have to say about this?

My lib brother-in-law asked me that question a while back and I told him that I invest in companies that make me money and I got no problem with others getting rich too. 

If that's bad you can tell me what I'm missing, but imho Newsweek is full of cr@p.

[sgtyork]

The first sentence tells me all I need to know about the Leftyopinionweek article.

BTW aren’t their enough American kids going into jourolism, or is this another job Ameriacns won’t do?

[Mind-numbed Robot]

I remember Drucker noting that after CEO-to-worker pay ratios went above 25–1,especially during turbulent times, major moral questions started to be raised.

I responded specifically to this and I asked you which moral issues were in play? You chose to shift the point to economics rather than morals. I don't disagree with you or Drucker on the economics but I am interested in the concept of morality in business as far as pay differences go.

As far as your sports analogy is concerned, doesn't the quarterback make more than anyone else on most teams? Why?

[TN4Liberty]

I think we should calculate and publish the difference in income (not pay) between the members of congress and the lowest paid person in their state/district, then cut their pay accordingly. I don’t think a congressman should make more than ten times the income of their lowest paid constituent, do you?

I’d be happy with calculating wealth and doing the same thing... tax away Congressional wealth until they are only ten times the average wealth for their district.

Now THAT’S a proposal we can rally around.

[kalee]

I agree.

[dfwgator]

If there was one thing I would do, is to get rid of interlocking directorates. That would go a long way towards solving this.

[proxy_user]

I have no problem with this, but too many companies employ high-paid turkeys who run them into the ground.

I could cite Carly Fiorina, Jeff Immelt, and William Weldon.

I won’t even go into those champion phonies, Chuck Prince and Angelo Mozilo.

[algernonpj]

BTW aren’t their enough American kids going into jourolism, or is this another job Ameriacns won’t do?

Good Catch! The list just keeps growing.

[SeekAndFind]

I quoted Drucker. I did not say I agree with him.

Therefore, the question you have should be addressed to his disciples, not me.

AS for Quarterbacks, I believe they get paid more for the PERCEIVED importance of their position. Many claim that their importance to an offense and a team’s success is indisputable.

Of course there are others who argue that this is overlooking the importance of defense. The defensive side of the ball does create some room for discussion as to which pieces are more critical than others in a team.

[Mind-numbed Robot]

I remember Drucker noting that after CEO-to-worker pay ratios went above 25–1,especially during turbulent times, major moral questions started to be raised.

If you don't agree with it why did you post it? What value does it have otherwise? You don't defend it because it is not defensible.

AS for Quarterbacks, I believe they get paid more for the PERCEIVED importance of their position.

I believe they get paid more because each offensive play starts with them and they sometimes have to make quick, on-the-spot decisions. It is also their playing skills which determine success or failure of the endeavor. They are very much the CEO on the field.

Yet, the CEO is not the whole company. He is totally dependent on the execution, decision making and skills of the rest of the team. He just makes more because he is at the top of the structural pyramid. However, that is a generalization rather than a hard and fast rule. There are companies where commissioned salesmen make more than the CEO and smart CEO's applaud them.

[dfwgator]

I believe they get paid more because each offensive play starts with them and they sometimes have to make quick, on-the-spot decisions. It is also their playing skills which determine success or failure of the endeavor. They are very much the CEO on the field.

Simple supply and demand, there are very few good quarterbacks.

You could make the case that a good kicker is just as vital to a team, but they are a dime-a-dozen, hence, they aren't paid nearly as much, although I'm sure a kicker that would consistently make 70-yard field goals, would be very well paid.

[SeekAndFind]

RE: If you don’t agree with it why did you post it? What value does it have otherwise? You don’t defend it because it is not defensible.

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You don’t have to agree with something to post something, otherwise FR will simply be a forum where people only post the articles of people they agree with.

One can also post OPPOSING views in order to elicit refutations.

[Mind-numbed Robot]

One can also post OPPOSING views in order to elicit refutations.

Was that your intent? If so, you sure danced around it a lot.

[Oceander]

You can question all you want to, but you'd be better off if you thought about it a little bit first. There are, basically, two starting points: (a) CEO pay, whatever it is, represents the fair market value of CEO services because shareholders, through their directors, and CEOs have negotiated a price for the CEO's services that both see as the best return on investment available to each (which does not have to mean that money is not being "wasted," all it means is that, under the circumstances, the deal negotiated is regarded as the best that's possible), or (b) there are uneconomic transaction costs (usually in the form of government-caused distortions, but they can also be due to significant informational asymmetries too) that the CEOs are arbitraging in order to obtain rent-seeking profits for their services. The first option - (a) - should be the presumptive baseline, unless we're ready to concede that we're in a command-and-control economy already. However, that does not mean that (b) is incorrect. In point of fact, there are a number of candidates for market-distorting transaction costs. Firstly, there are the distortions introduced by the tax code.

For example, there are the so-called "Golden Parachute" provisions that disallow a corporation's deductions for compensation paid to an upper management officer over $1 million (at least, that's what I believe the limit was last time I checked - it's been a while), unless - and here's the important part - the compensation paid in excess of $1M is performance pay (i.e., amounts paid to the CEO for meeting certain objective performance benchmarks such as having the common stock hit a certain market valuation). That means that corporations that would otherwise prefer to pay a CEO, say, $2M in straight salary (assuming arguendo that this represents a fair market value for the CEO's services) will instead be incentivized to pay a base salary of $1M, with a performance bonus that the parties expect and intend will, generally speaking, yield an additional compensation income of $1M. The problem is, people are generally not as good at valuing future income streams that are subject to risk, and are prone to either under- or over-valuing those streams, depending on both their innate risk appetite as well as the economic benefit they stand to gain (or cost they stand to incur) based on such valuations.

Now, if we bring in another problem based on human behaviour - that boards of directors have less incentive to drive a hard bargain on performance compensation than an individual officer does - it becomes more likely that a board of directors (or, more precisely, the compensation committee of the board) will accede to a valuation that tends to yield more than $1M in additional compensation for that CEO.

Thus, something as seemingly innocuous as the "Golden Parachute" provisions of the Internal Revenue Code end up creating market distortions that lead to higher than market pay for CEOs. As an aside, this is also another in a too-long line of examples of liberal/democrat legislation with unintended consequences that more than undercut the ostensible purpose for the legislation in the first place. That is, the Golden Parachute provisions were supposed to limit or reduce the pay of corporate officers, but they have instead had the effect of increasing the pay of corporate officers.

Another market distortion caused by the Internal Revenue Code comes from the disproportionate treatment of long-term capital gains, short-term capital gains, and dividends. Because dividends and short-term gains are taxed at a much higher rate than long-term capital gains are (the provisions taxing "qualified dividends" at the long-term capital gain rates are of recent vintage - 2003/2004 - and are scheduled to sunset on 12/31/2010), the tax code incentivizes individuals to realize gains on their investments through long-term capital gains rather than through short-term capital gains or, more importantly, through dividends.

In other words, the tax code has distorted the market by causing shareholders to prefer long-term capital gains - sales to others based on perceptions of the future growth of the corporation's stock value, however determined - rather than preferring short-term gains (which are more dependent on the current performance of a corporation rather than on its long-term prospects) or dividends (which are, almost by definition, based on how the corporation has already performed in the current year).

The problem then becomes, not how to maximize the corporation's current, or near-term performance, but rather how to maximize its long-term potential. That, of course, runs afoul of the problem noted above about humans' difficulties in valuing future income streams. It also means that directors (and shareholders) become vulnerable to the sales pitch from superstar CEOs (think Jack Welch), and from not-so-superstar officers who have the ability to position themselves as up-and-comers, that the corporation's long-term performance is dependent on their abilities to lead.

This is not an altogether farfetched or irrational view, because in many cases a good leader can improve performance over and above what a bad or middling leader can achieve. However, because of the tax code incentives to focus only on long-term market gains to the exclusion of all else means that the government has, again, distorted the market and created an asymmetry that CEOs can arbitrage to obtain rent-seeking profits. In other words, the tax code has caused directors and investors to focus too much on hiring the best leader who will, they believe (a subjective belief that may, or may not, be grounded in realities), maximize the long-term value of their stock in the market. That of course, means that they pay less attention to that putative leader's ability to maximize the short-term value of their stock, and more importantly, the current or near-term performance of the corporation itself. Another point that should be made explicit is this: to the extent that the determinative factor is whether or not the CEO will be able to maximize the long-term market value of the shareholders' stock, and to the extent that such value is determined by factors other than the corporation's current performance at that point in time (which is usually the case, particularly when most potential buyers are, like the existing shareholders before them, incentivized to consider their own long-term value as opposed to the then-current performance of the corporation), the shareholders in the here and now will prefer paying more for a CEO who convinces them that she or he will be the best at maximizing the long-term market value of their stock than paying for a CEO who merely convinces them that she or he will improve the near-term performance of the corporation itself (e.g., as measured by net earnings).

So, once again, we see how the tax code, through apparently innocuous provisions, has so distorted the market for CEO services that CEOs are able to arbitrage the resulting inefficiencies to obtain rent-seeking profits. Fixing those market distortions will require much, much more than simply railing publicly about the "greed," "avarice" and general unfairness of CEOs and current corporation compensation practices.

[starlifter]

Any examples?

[SeekAndFind]

RE: Was that your intent? If so, you sure danced around it a lot.

Yes that was my intent. And I am not dancing around it.

[truth_seeker]

Huge problem with American business had been the trend to stack Boards of Directors with politically correct professors.

Most companies have their designated black board member (what is Vernon Jordan for?) and their designated woman board member and their designated hispanic board member.

These people are often professors, or corporate “rainmakers” who know virtually nothing about the industry.

And they are paid a ton more than they historically were paid. So they rubberstamp management.

This trend was to offset “insiders” on boards, who were execs of the company and knew the business.

The consequence of all this is the Chairman and the CEO are more powerful, ruling the board and all policies.

No wonder they get such big bucks.

[starlifter]

Your argument is flawed in that there is not a free exchange of information and BODs are heavily;y invested in keeping the status quo. For example, look at the cross membership in various boards, viz., I'll vote for your higher pay package and you'll vote for mine.

The fair market value necessarily implies a willing buyer and a willing seller. Proxy rules today substantially limit shareholder ability to nominate independent board members. Actually, a more reasonable example (though still imperfect) is the election cycle and, hopefully, the expected outcome this November.

Look at Fannie and Freddie, arguably one of the most corrupt examples of free market corporate governance.

The fair market theory is an excellent theoretical construct, but there are few if any examples of the free market in large corporate governance.

Lastly, the blame does not lie exclusively with the liberal and democrats (though I dislike and distrust them intensely). Republicans are as much to blame for market distorting tax codes as anyone else. In fact, they cloak themselves in moral superiority while continuing to play the game with their buds. Let's see if the Republicans gain one or both houses if they live up to moral principles or if they squander their mandate...again.

[SeekAndFind]

RE: Huge problem with American business had been the trend to stack Boards of Directors with politically correct professors.

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I have always wondered if Nobel Prize winner, Paul Krugman is one of those you mentioned.

How about Al Gore ?

[SeekAndFind]

RE: Look at Fannie and Freddie, arguably one of the most corrupt examples of free market corporate governance.

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I tended to agree with you ... but Fannie and Freddie for me should NOT be included as Private companies in the same manner as say, GE or Microsoft.

They were and still are IN EFFECT, government companies despite the impression they want people to have.