Pay without Performance

by John Q on December 11, 2004

I’ve been reading “Pay without Performance : The Unfulfilled Promise of Executive Compensation” by Bebchuk and Fried) For anyone who still believes that executive pay is based on rewarding performance, and encouraging risk-taking, this book should disabuse them. There are loads of studies pointing out, not surprisingly to anyone who reads the papers, that top executives and boards look after each other in a way that rewards failure.

The most telling detail for me is the observation p98, that every single CEO in the S&P Execucomp Database has a defined benefit pension plan. This, while bosses everywhere have been shifting their employees onto defined contribution plans, where they, and not the company, bear all the risk, and while the Republicans in the US are trying to do the same with Social Security.

One thing I would have liked more of is quantitative information about the aggregate magnitude of payments to executive pay, considered in relation to corporate profits. There’s only a little of this in the book, though the authors say here

Aggregate top-five compensation was equal to 10 percent of aggregate corporate earnings in 1998-2002, up from 6 percent of aggregate corporate earnings during 1993-1997.

Given that this excludes various kinds of hidden transfers[1], that non-executive board members extract substantial rents (mostly through favorable corporate decisions rather than in cash) and considering senior managers, rather than merely top-5 executives, as a class, it’s apparent that the total income flowing to this group could easily be between 25 and 50 per cent of aggregate corporate profits. If this is correct, it ought to have profound implications for the way in which we model corporations, and the way in which we think about the class structure of modern capitalism.

fn1. It’s not clear whether retirement benefits are counted, for example, and these are as large, in present value terms, as direct compensation. Then there is the observation that executive insiders do remarkably well in trading the shares of their own companies.

{ 19 comments }

1

bad Jim 12.11.04 at 8:47 am

Not to mention the tax policies of the Bush administration.

2

abb1 12.11.04 at 4:30 pm

If this is correct, it ought to have profound implications for the way in which we model corporations, and the way in which we think about the class structure of modern capitalism.

curious of what it is exactly you count for ‘capitalism’, because this phenomenon seems to be very much US-specific: EXECUTIVE PAY

3

Walt Pohl 12.11.04 at 5:10 pm

I’m beginning to wonder if Marx was right about class warfare, and that the only thing that restrained business leaders for most of the past century was the threat of the Soviet Union.

4

Steve Carr 12.11.04 at 5:18 pm

Walt, I’m not sure how this would make you think Marx would be right, since the people who are really getting ripped off by senior managers are shareholders — that is, capital.

5

Walt Pohl 12.11.04 at 5:59 pm

I should have known if I said “capitalist” someone would be picky. How about “captains of industry”?

6

Steve Jandreau 12.12.04 at 1:56 am

After reading this, I was reminded of what a great liberal economist wrote about the dangers of separating management from ownership:

The directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own….Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company. The Wealth of Nations, Book V, Part 3, Article 1

7

Steve Jandreau 12.12.04 at 1:57 am

After reading this, I was reminded of what a great liberal economist wrote about the dangers of separating management from ownership:

The directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own….Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company. The Wealth of Nations, Book V, Part 3, Article 1

8

Steve Jandreau 12.12.04 at 1:58 am

After reading this, I was reminded of what a great liberal economist wrote about the dangers of separating management from ownership:

The directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own….Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company. The Wealth of Nations, Book V, Part 3, Article 1

9

Steve Jandreau 12.12.04 at 1:59 am

After reading this, I was reminded of what a great liberal economist wrote about the dangers of separating management from ownership:

The directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own….Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company. The Wealth of Nations, Book V, Part 3, Article 1

10

Steve Jandreau 12.12.04 at 2:00 am

After reading this, I was reminded of what a great liberal economist wrote about the dangers of separating management from ownership:

The directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own….Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company. The Wealth of Nations, Book V, Part 3, Article 1

11

Steve Jandreau 12.12.04 at 2:01 am

After reading this, I was reminded of what a great liberal economist wrote about the dangers of separating management from ownership:

The directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own….Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company. The Wealth of Nations, Book V, Part 3, Article 1

12

Steve Jandreau 12.12.04 at 2:02 am

After reading this, I was reminded of what a great liberal economist wrote about the dangers of separating management from ownership:

The directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own….Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company. The Wealth of Nations, Book V, Part 3, Article 1

13

Walt Pohl 12.12.04 at 2:04 am

I believe we have a new record.

14

gordon 12.12.04 at 4:56 am

Ripping off shareholders also means ripping off institutional investors, which handle the savings (eg. super) of working people. So it’s not only capital which is being ripped off. And as far as class war is concerned, isn’t it a wonderful irony of late 20th century politics how just as “left” parties were ostentatiously deleting Marxism and class war from their platforms, “right” parties were embracing it!?

15

joejoejoe 12.12.04 at 8:06 am

I thank you for posting that Adam Smith quote and I curse the Invisible Hand for posting it another 6 times. Damn you Invisible Hand! Damn you all to hell!

16

abb1 12.12.04 at 10:21 am

Ripping off shareholders

This is not just about ‘ripping off shareholders’, this is far beyond ‘ripping off shareholders’. As John said in his post, this has profound implications.

But I’m not sure this can be accurately called ‘capitalism’ anymore, the expression is ‘crony capitalism’.

17

Russkie 12.12.04 at 10:38 am

As someone who has been screwed more than once by know-nothing CEOs and venture capitalists, I certainly agree that the way these people get compensated has little connection with their competence or ability to provide value to shareholders.

Thing is that it’s a lot easier to complain about it than it is to suggest a practical solution. Executive compensation is sky-high currently because of 2 factors that I can see: 1) executive competence is rare and is one of the 2 most basic factors that can make an enterprise successful in the globalized competitive environment (the other one is luck) 2) there is a distinct lack of transparency that surrounds what a CEO actually contributes.

It could be said that engineers had these same 2 things going for them during the bubble period.

18

burritoboy 12.12.04 at 6:26 pm

Rakesh Khurana’s book on the same subject is also very good.

19

gordon 12.12.04 at 10:15 pm

Russkie thinks that executive compensation is “sky-high” at the moment partly because “executive competence is rare”. I suspect that there is not such a shortage of talent as he thinks. A considerable literature on employee involvement in management and workplace democracy indicates that there is plenty of talent, but few ways that it can be expressed.

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